ACCOUNTING  STUDENTS' 
SERIES 


Accounting  Principles 


By 
SAMUEL    F.    RACINE 

Certified  Public  Accountant 

Branch  Office  and  Corporation  Accounting 
Specialist  and  President  The  Western  Insti- 
tute of  Accountancy,  Commerce  and  Finance 


1913 


Copyright,  1913,  by 
SAMUEL  F.   RACINE 


Published  by 
THE  WESTERN  7NSTTTUTO -OF' ACCOUNTANCY,  COMMERCE 

AND  FINANCE 
Leary  Building,  Seattle 


Press  of 
LOWMAN  &  HANFORD  PRINTING  AND  STATIONERY  COMPANY 


PREFACE 


During  the  time  we  have  been  conducting  the  Western 
Institute  of  Accountancy,  Commerce  and  Finance,  we 
have  been  considerably  handicapped  by  not  having  a 
book  sufficiently  complete  or  reliable  as  a  treatise  on  the 
principles  of  accounting;  correspondence  with  other  col- 
leges and  universities  discloses  that  they  also  have  felt 
the  need  of  a  more  authentic  work  on  the  subject,  and 
this  work  is  intended  to  provide  such  institutions,  and 
also  the  hard  working,  conscientious,  evening  student  with 
a  book  that  will  answer  the  requirements  and  will  bridge 
the  distance  between  Bookkeeping  and  Advanced  Ac- 
counting. Our  task  has  been  not  only  to  cover  the  field 
of  the  (\  I*.  A.  Examinations  but  also  to  confine  the  work 
within  one  volume. 

The  author  wishes  to  express  his  sincere  gratitude  to 
his  friends  who  so  kindly  offered  suggestions  and  criti- 
cisms and  to  whom  much  of  the  merit  of  this  book  belongs. 

SAMUEL  F.  RACINE,, 
Seattle,  1913.  Certified  Public  Accountant. 


259692 


CONTENTS 


CHAPTER  I. 
BOOKKEEPING 

PAGES 

Defined;  Methods;  Single  Entry;  Double  Entry;  Advan- 
tage of  Double  Entry  in  Business  Accounts;  Disadvan- 
tages of  Double  Entry;  Municipal;  Objections  to  Usual 
Form;  C.  P.  A.  Questions 1-7 

CHAPTER  II. 
SINGLE  ENTRY. 

Proving  Accuracy  of  Posting;  The  Audit  of;  Statement  of 
Affairs;  Statement  of  Assets  and  Liabilities;  Ascer- 
taining Profit;  Resource  and  Liability  Method;  Prepar- 
ing a  Profit  and  Loss  Account;  Changing  to  Double 
Entry;  Journal  Entry;  C.  P.  A.  Questions 8-16 

CHAPTER  III. 
ACCOUNTS   AND   ACCOUNTING;    ACCOUNTS — CHARACTER. 

Account  Defined;  Accounting  Defined;  Accountant  De- 
fined; Certified  Public  Accountant  Defined;  Division 
of  Accounts;  Character;  Personal;  Impersonal;  C.  P. 
A.  Questions  17-23 

CHAPTER  IV. 
ACCOUNTS — FORM. 

Construction  of  Account  Forms;  Journal  Forms;  Standard; 
Debits  and  Credits  Widely  Separated;  Ledger  Forms; 
Standard;  To  Facilitate  Reference  Between  Debits  and 
Credits;  Showing  Balances;  Additional  Columns  for 
Monthly  Totals;  Detail  Columns;  Combined;  Capital 
and  Income;  Capital  Stock  and  Subscription;  Wide  Ex- 
planation Columns;  Special  Information;  Leaders; 
Folios  Classified;  Amounts  Classified;  Boston  Bank 
Ledger;  Membership  Ledger;  Narrow  or  Short  Pages; 
Questions  for  Written  Work....  24-37 


x  CONTENTS 

CHAPTER  V. 

CLASSIFIED  JOURNALS. 

PAGES 

Advantages  of  Classifying;  Classified  by  Books;  by  Pages; 
by  Columns;  Tabular  Proof;  Sales  Book;  Invoice 
Book;  Purchase  Journals;  Questions  for  Written  Work  38-41 


CHAPTER  VI. 
CASH  RECORDS. 

Cash  Book;  Two  Column;  Tabular;  Treatment  of  Dis- 
counts; Memorandum  Columns;  Standard  Columns; 
Daily  Balance  Book;  Advantages  of;  Separate  Book  for 
Cash  and  Bank;  Check  and  Deposit  Register;  Ques- 
tions for  Written  Work....  42-51 


CHAPTER  VII. 
ACCOUNTS — CONTENTS. 

Major;  Individual;  Mixed;  Specific;  Collective;  Summary; 
Subsidiary;  Rest  or  Deposit;  Current;  Adjuncts;  Off- 
sets; Mixed  Accounts;  How  Created;  Principal  Ones; 
Merchandise;  Interest  and  Discount;  Freight  and  Ex- 
press; Machinery  or  Equipment;  Equipment  Ledger; 
Plant;  Land  and  Buildings;  Goodwill;  Treasury 
Stock;  Expense;  Rent,  Insurance,  Heat,  Etc.;  C.  P.  A. 
Questions 52-65 


CHAPTER  VIII. 
INDIVIDUAL  OR  SPECIFIC  ACCOUNTS. 

Accounting  Requirements;  Principal  Specific  Accounts  and 
Their  Contents;  Purchases;  Sales;  Gross  Profit;  In- 
ventory; Valuing  Stock;  Raw  Material;  Partly  Manu- 
factured Goods;  Finished  Goods;  C.  P.  A.  Questions....  66-79 

CHAPTER  IX. 
CASH. 

Statement  of  Receipts  and  Disbursements;  Statement  of 
Revenue  and  Expenses;  Statement  of  Income  and  Ex- 
penditures; Proper  Items  in  a  Cash  Account;  Certifi- 
cates of  Deposit;  Trust  Funds;  I.  O.  U.'s;  C.  P.  A. 
Questions 80-83 


CONTENTS  xi 

CHAPTER  X. 

CAPITAL  AND  REVENUE. 

PAGES 

Capital  Income;  Capital  Expenditures;  Working  Capital; 
Fixed  Assets;  Current  or  Floating  Assets;  Fixed  Lia- 
bilities; Current  or  Floating  Liabilities;  Revenue  In- 
come; Revenue  Expenditures;  Capital  and  Revenue; 
Proper  Charges  to  Capital;  Proper  Deductions  from 
Capital;  Proper  Charges  to  Revenue;  Mines,  Quarries, 
Etc.;  C.  P.  A.  Questions 84-89 

CHAPTER  XI. 
INVESTMENTS. 

Investments  in  Real  Estate;  Investments  in  Stocks;  In- 
vestments in  Bonds;  Investments  in  Securities;  C.  P. 
A.  Questions  90-98 

CHAPTER  XII. 

CAPITAL  ASSKTS. 

Their  Treatment  When  Purchased  With  Money;  When  Pur- 
chased With  Properly;  Organization  Expenses;  Bonds 
Issued  for  Construction  Purposes;  Proper  Charges  to 
Capital  After  Organization;  Double  Account  System; 
Articles  Prepared  for  Use  of  Firm;  Moving  and  Alter- 
ing; Replacements;  Conversions;  Appreciation  From 
Outside  Sources;  C.  P.  A.  Questions 99-113 

CHAPTER  XIII. 

DEPRECIATION. 

Depreciation  Defined;  Depreciation  Charge;  What  It  In- 
cludes; Necessity  of  Providing  for  Depreciation; 
Methods  of  Computing;  Interest;  Annuity  System;  Re- 
placement Fund;  Effect  of  Each  Plan;  Repairs  and  Re- 
newals; Obsolescence;  Abandonment  of  Property;  Sale 
of  Property;  Wasting  Assets;  Rates  on  Different  Ob- 
jects; Land  and  Appurtenances;  Machinery;  Equip- 
ment; Horses;  Tools;  Patterns;  Patents;  Goodwill; 
Table  of  Residual  Values;  C.  P.  A.  Questions....  ....114-139 

CHAPTER  XIV. 

GOODWILL. 

Computing  Value:  Based  on  Excessive  Profits;  Affected  by 
Various  Conditions;  What  Are  Excessive  Profits? 
Manipulation  of  Accounts;  Writing  It  Up;  Anticipated 
Profits;  Upon  Sale  of  Portion  of  Undertaking;  With- 
drawal of  Partner;  Writing  Off  Goodwill;  Badwill; 
C.  P.  A.  Questions 140-154 


xii  CONTENTS 

CHAPTER  XV. 

LIABILITIES. 

PAGES 

Liabilities;  Contingent  Liabilities;  Capital  Liabilities; 
Fixed  Liabilities;  Proprietorship;  C.  P.  A.  Ques- 
tions   155-161 

CHAPTER  XVI. 

SUBSIDIARY  ACCOUNTS. 

Use  of  Subsidiary  Accounts;  Deferred  Charges;  Insurance 
Paid  in  Advance;  Advertising  Appropriations;  Ex- 
penses Incurred  in  .Advance  of  Sales;  Discount  on 
Bonds;  Suspense  Accounts;  Accrued  Items;  Expenses; 
Deferred  Credits;  Premium  on  Bonds;  Premium  on 
Stock;  C.  P.  A.  Questions....  ...162-170 

CHAPTER  XVII. 
RESERVES. 

Kinds  of;  Reserve  Accounts;  Reserve  for  Bad  Debts;  Re- 
serve for  Depreciation;  Reserve  for  Fire  Losses;  Re- 
serve for  Deterioration  of  Stock;  Reserve  Funds;  The 
Term  "Fund";  How  Created;  Secret  Reserves;  Advan- 
tages and  Disadvantages;  C.  P.  A.  Questions 171-189 


CHAPTER  XVIII. 
RESERVE  INVESTMENTS. 

Reason  For;  Sinking  Fund  Investments;  Reserve  Fund  In- 
vestments; Investments  and  Reserves;  Assets  or  Lia- 
bilities; Treatment  of  Income  on  Investments;  Agree- 
ment of  Accounts;  Reserve  Accounts  and  Accretions; 
Effect  of  Losses;  Liquidating  the  Investment;  Satisfy- 
ing the  Obligation;  Disposition  of  Reserve;  C.  P.  A. 
Questions  ...  ...190-206 

CHAPTER  XIX. 
MISCELLANEOUS    SUBSIDIARY   ACCOUNTS. 

Divisions  of  Cash  Account;  Bank  Account;  Petty  Cash; 
Reconciliation  of  Bank  Pass  Book  and  Bank  Account; 
Lapping  System;  Imprest  Cash;  Revolving  Fund; 
Cash  at  Bankers;  Division  of  Sales;  Cash  Sales;  Pur- 
chases; Cash  Purchases;  Division  of  Inventories;  C. 
P.  A.  Questions 207-215 


CONTENTS  xiii 

CHAPTER  XX. 

MISCELLANEOUS  COLLECTIVE  ACCOUNTS. 

PAGES 

Bills  Receivable  Account;  Bills  Receivable  Ledger;  Sundry 
Debtors;  Sundry  Debtors'  Ledger;  Controlling  Ac- 
count; Adjustment  Account;  Subscription  Account; 
Capital  Stock  Account;  Stock  Ledger;  Dividends 
Payable  Account;  Expense  Account;  Expense  Ledger-: 
Salaries  Account;  Salaries  Ledger;  Materials  Account; 
Stores  Ledger;  Accounts  Receivable;  Sales  Ledger; 
Purchase  Ledger;  Plant  Account;  Plant  Ledger;  In- 
vestment Accounts;  Investment  Ledger;  Suspense  Ac- 
count; Suspense  Ledger;  Private  Ledger 216-232 

CHAPTER  XXI. 
TRIAL  BALANCE. 

Trial  Balance;  Proof  by  Footings;  Proof  by  Balances- 
Proof  by  Charges  and  Credits;  C.  P.  A.  Questions 233-237 

CHAPTER  XXII. 
PROFIT  AND  Loss. 

Profit  and  Loss  Account;  Manufacturing  Section;  Trading 
Section;  Administration  Section;  Net  Profit  Section; 
Profit  and  Loss  Appropriation  Section;  C.  P.  A. 
Questions  238-246 

CHAPTER  XXIII. 
BALANCE  SHEET. 

Defined;  Value  of;  Fact  or  Opinion;  Offsets  and  Adjuncts; 
Prepared  for  Bankers;  Grouping  the  Items;  Form;  C. 
P.  A.  Questions  247-254 

CHAPTER  XXIV. 
CLASSIFIED  JOURNALS — CONTINUED. 

Advantages  of  Tabular  Books;  Cash  Journals;  Ledger 
Journal;  Voucher  Register;  Form  of  Voucher;  Form  of 
Voucher  Register;  Operation  of  Voucher  System; 
Voucher  Distribution  Ledger;  C.  P.  A.  Questions 255-274 


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ACCOUNTING  PRINCIPLES 


CHAPTER  I. 

Bookkeeping 
Defined. 

"The  art  of  keeping  a  systematic  record  of  business 
transactions,  so  as  to  show  their  relation  to  each  other 
and  the  state  of  the  business  in  which  they  occur;  art  of 
keeping  accounts."  (Webster.) 

"The  art  of  recording  business  transactions,  with  the 
view  of  having  a  permanent  record  of  them  and  of  show- 
ing their  effect  upon  wealth."  (Lisle.) 

Methods. 

As  to  the  methods  of  keeping  the  records,  bookkeep- 
ing may  be  divided  into  two  classes:  Single  Entry  and 
Double  Entry. 

Single  Entry. 

Sinle  ED  try ;  or  Simple  Entry  as  it  is  sometimes 
a  name  given  to  any  of  the  various  plans  of 
recording  transactions  which  show  them  only  in  the  re- 
lalion  they  bear  to  persons.  Its  form  and  completeness 
depend  greatly  on  the  knowledge  and  ingenuity  of  the  per-/ 
son  keeping  the  records.  In  many  cases  there  is  just  an 
ordinary  ledger,  such  as  is  used  in  double  entry  bookkeep- 
ing, with  date,  explanation  and  money  columns  arranged 
for  both  charges  and  credits,  and  with  an  account  or  page 
for  each  person.  The  party  keeping  the  record,  records 


2  ACCOUNTING  PRINCIPLES 

the  items  or  transactions  in  the  order  of  their  occurrence 
on  either  the  debit  or  the  credit  side  as  the  case  may  be. 
He  usually  dwells  rather  fully  on  the  transaction  in  the 
explanation  columns  and  keeps  a  fairly  complete  record. 
Another  plan  often  met  with  is  that  of  keeping  a 
memorandum  of  transactions,  in  the  order  of  their  occur- 
rence, in  a  Blotter  or  Day  Book,  then  transferring  them 
into  a  Ledger,  classified  according  to  customers.  This 
memorandum  may  take  any  form  whatsoever.  It  usually 
gives  the  name  of  the  person  with  whom  the  firm  has 
dealt  and  also  outlines  the  transaction  fully,  giving  a 
list  of  the  articles  dealt  in,  the  amount  of  money  paid  or 
received,  etc.  It  is  intended  to  be  a  complete  history  of 
the  transaction  and  has  been  known  to  go  even  so  far 
as  to  mention  the  witnesses  to  the  transaction  and  their 
views  as  to  a  purchaser's  prospect  of  paying  the  account. 
In  the  majority  of  cases  some  sort  of  an  account  is  also 
kept  to  show  the  Investment  or  the  Proprietary  Interest 
in  the  firm.  Owing  to  its  many  imperfections,  it  is  grad- 
ually going  out  of  use ;  however,  it  is  still  to  be  found 
amongst  the  uninformed  and,  as  it  offers  a  number  of 
interesting  points  for  consideration,  it  will  be  taken  up 
again  in  another  chapter. 

Double  Entry. 

Double  Entry  is  that  form  of  bookkeeping  which  con- 
tains two  records  of  each  transaction,  one  a  charge  and 
the  other  a  credit  to  the  respective  accounts  affected. 

This  plan  is  impossible  where  only  personal  accounts 
are  used  and,  in  order  to  complete  the  double  entry  and 
to  show  the  effect  of  the  transaction  on  the  business  or 
institution,  accounts  are  required,  in  addition,  to  record 
the  integral  units  of  operations — such  things  as  Earn- 
ings, Expenses,  Property  or  Rights  acquired  and  Liabili- 
ties incurred  in  their  acquisition. 


BOOKKEEPING  3 

As  to  completeness,  Double  Entry  Bookkeeping  may 
be  divided  into  two  classes,  one  showing  the  receipts  and 
disbursements,  the  income  and  expenditures  and  the  re- 
sources and  liabilities ;  the  other  only  showing  the  receipts 
and  disbursements. 

The  former  is  known  as  the  Capital  and  Revenue 
method  and  the  latter  the  Receipts  and  Disbursements 
method. 

The  Capital  and  Revenue  Method  is  used  by  all  con- 
cerns conducted  for  profit,  while  the  other  is  used  only 
by  those  institutions  which  have  no  investment  and 
which  are  not  conducted  for  profit. 

The  object  of  every  business  is  to  increase  the  pro- 
prietary interest  in  the  concern  and,  from  the  standpoint 
of  the  proprietor,  the  most  interesting  feature  of  the  bus- 
iness is  its  effect  on  his  investment;  therefore,  the  most 
important  object  of  bookkeeping  is  to  record  the  growth 
or  decline  of  Capital  or  Proprietorship.  As  only  Double 
Entry  Bookkeeping  records  the  transaction  from  this 
standpoint,  it  is  used  almost  to  the  exclusion  of  Single 
Entry. 

With  books  kept  entirely  by  Single  Entry,  the  Profit 
or  Loss  of  a  given  period  is  ascertained  by  a  comparison 
of  the  Net  Worth  of  the  concern  at  one  date  and  its  Net 
Worth  at  some  previous  date.  The  tendency  being  to  as- 
sume that  all  changes  occurring  in  the  Net  Worth  are 
due  to  the  operation  of  the  business  and  profits  arising 
owing  to  the  sale  of  Fixed  Assets  or  from  Outside  Invest- 
ments, although  really  foreign  to  the  operation  of  business, 
are  often  included.  -, 

With  complete  Double  Entry,  the  profit  is  not  only 
ascertained  as  in  Single  Entry  by  a  comparison  of  the        I 
Net  Worth  at  different  periods,  but  it  is  also  ascertained       / 
by  using  the  accounts  representing  the  progress  of  the      / 


4  ACCOUNTING  PRINCIPLES 

business.  These  accounts  contain  all  transactions  which 
have  an  effect  on  the  income  of  the  concern  and  reflect 
the  various  causes  that  have  produced  the  Profit  or  Loss. 
In  addition  to  this,  owing  to  the  careful  classification 
of  the  items,  Losses  or  Profits  that  have  occurred  from 
sources  outside  of  the  business  are  separated  from  the 
Ordinary  Business  Profits  or  Losses  and  the  effect  of  the 
operation  of  the  business  is  not  misrepresented. 

Double  Entry  possesses  so  many  advantages  over  Sin- 
gle Entry  that  many  exaggerated  claims  are  made  for  it ; 
for  instance,  it  is  often  stated  that  the  Profit  or  Loss  of 
a  business  can  be  immediately  ascertained  from  books 
kept  by  Double  Entry,  and  that  Double  Entry  books  at 
all  times  show  accurately  the  status  of  the  business  for 
which  they  are  kept ;  whereas,  the  Profit  or  Loss  can  only 
be  ascertained  from  the  majority  of  Double  Entry  books 
after  an  inventory  of  the  assets,  and  even  then,  owing  to 
the  many  theories  as  to  the  proper  method  of  valuing 
the  assets  and  to  the  impossibility  of  determining  with 
any  degree  of  accuracy,  the  true  value  of  much  of  the 
property,  the  inventory  value  as  stated  is  only  an  ap- 
proximation and  likewise  the  Profit  or  Loss  resulting  is 
but  an  estimate  of  the  correct  result.  It  is  also  impos- 
sible to  determine  accurately  the  proper  value  of  prop- 
erty consumed  in  conducting  the  business  and  this  also 
has  a  tendency  to  disturb  the  accuracy  of  the  results. 

There  are  also  some  items  which,  although  of  great 
value  to  the  firm,  cannot  be  placed  on  the  books  at  all. 
The  most  important  of  these  are  the  Skill  and  Experi- 
ence of  its  proprietors  or  the  Right  to  exercise  some  mo- 
nopoly. 

Often  acts  are  performed  during  one  period  of  op- 
erations which  do  not  become  an  active  liability  until 
some  later  date.  These  acts  occurred  at  the  previous  date 


BOOKKEEPING  5 

and,  if  Double  Entry  Bookkeeping  did  all  that  was  claim- 
ed for  it,  the  liabilities  would  appear  in  the  books.  They, 
however,  are  usually  omitted  until  they  actually  demand 
attention. 

Liabilities  of  this  sort  are  known  as  Contingent  Lia- 
bilities and,  in  general,  if  given  effect  at  all,  are  simply 
appended  to  the  Balance  Sheet  as  a  foot  note.  The  prin- 
cipal ones  are  ''Bills  Receivable  Discounted"  and  "Lia- 
bility on  Guaranteed  Goods." 
Municipal. 

Municipal  Accounting,  although  operated  on  the  Dou- 
ble Entry  principle  of  carrying  accounts  with  inanimate 
tilings  and  of  having  a  debit  and  a  credit  for  each  trans 
aciion,  differs  in  the  nature  of  the  information  it  is  in- 
tended to  impart.  In  the  majority  of  cases,  the  intejit  is 
to  display -only  the  receipt  and  the  disbursement  of 
money — special  stress  being  given  to  the  collection  of 
(axes,  licenses,  lines,  etc.,  and  to  the  disbursement  of 
funds  rather  than  to  the  asset  value  of  the  purchase  or 
the  effect  of  the  transaction  on  the  Proprietorship. 

The  books  of  a  Municipality,  operated  as  outlined 
above,  should  be  arranged  so  that  reports  prepared  there- 
from would  disclose  its  ability  to  liquidate  Current  Lia- 
bilities and  also  the  legal  margin  of  its  borrowing  pow- 
ers as  these  are  the  most  essential  things  in  estimating 
the  value  of  its  bonds  and  in  considering  the  propriety 
of  public  undertakings. 

Many  municipalities  are  endeavoring  to  operate  their 
accounts  under  the  Capital  and  Revenue  Method  men- 
tioned under  Double  Entry,  but  in  a  number  of  cases 
I  hey  are  not  having  the  success  they  anticipated,  in  fact, 
it  is  argued  that  so  long  as  a  municipalities'  principal  as- 
set— the  right  to  collect  taxes — is  of  such  a  nature  that 
it  can  not  be  placed  on  the  books  and  that  any  State- 


6  ACCOUNTING  PRINCIPLES 

ment  of  Assets  will  fall  far  short  of  the  actual  condi- 
tion of  affairs,  and  also  that,  as  the  borrowing  powers  of 
a  city  is  not  estimated  according  to  the  value  of  its 
Ledger  Assets,  it  is  unnecessary  and  incorrect  to  keep 
municipal  books  in  this  manner. 

Furthermore,  as  a  Municipality  is  not  operated  for 
profit,  it  is  claimed  that  the  keeping  of  Revenue  Ac- 
counts, the  purpose  of  which  is  to  display  the  sources 
and  the  disposition  of  the  profit  of  an  undertaking,  is 
useless  except  for  such  subsidiary  undertakings  as  Wa- 
ter Works  or  Electric  Light  Plants. 

It  seems,  however,  that  so  far  as  the  expenses  are 
concerned,  there  is  no  excuse  for  not  giving  them  effect 
as  they  occur,  in  order  to  properly  place  the  responsi- 
bility, and  also  that  there  is  no  excuse  for  not  keeping 
a  complete  record  of  the  various  properties  and  articles 
purchased.  To  this  extent,  the  original  plan  of  Municipal 
Accounting  can  undoubtedly  be  improved. 


BOOKKEEPING 


C.  P.  A.  Questions 

1.  Outline  concisely  the  principles  of  single  and  of 
double  entry.  (XXX) 

.!.  Define  double  entry  bookkeeping  and  state  wherein 
it  differs  from  single  entry  bookkeeping.  (Penn.) 

3.  Mention  the  methods  of  bookkeeping  in  general 
use.    How  is  the  profit  or  loss  ascertained  by  the  different 
methods?     (N.  Y.) 

4.  Wherein  do  Municipal  Accounts  differ  from  Pri- 
vate Accounts  as  to  Capitalization  and  Revenue?  (Penn.) 

5.  State  what,  in  your  judgment,  are  the  principal 
defects  of  the  prevailing  methods  of  municipal  account- 
ing.    What  is  your  conception  of  the  information  that 
should  be  given  in  the  periodic  statements  of  a  munici- 
pality?    (Wash.,  '08.) 

6.  a.     Name  some  of  the  differences  between  Munic- 
ipal Accounting,  as  it  is  generally  conducted,  and  Com- 
mercial Accounting. 

b.  Is  there,  in  your  opinion,  any  reason  why  Munici- 
pal Accounting  should  not  be  placed  on  a  Commercial 
basis,  and,  if  not,  how  can  this  be  accomplished?  (Wash., 
'07.) 


CHAPTER  II. 

Single  Entry 

It  is  often  said  that  one  of  the  principal  objections 
to  Single  Entry  books  is  that  it  is  impossible  to 
prove  the  work.  This  is  probably  true  in  so  far  as  it 
is  impossible  to  take  a  Trial  Balance  in  the  sense  of  the 
term  as  applied  to  Double  Entry  bookkeeping;  but  there 
is  nothing  to  prevent  the  proving  of  posting,  which  is  vir- 
tually taking  a  Trial  Balance,  where  a  Day  Book  with 
Debit  and  Credit  Columns  is  used  in  connection  Avith  the 
Ledger. 

This  is  accomplished  by  totaling  the  Debit  and  Credit 
columns  of  the  Day  Book  and  also  the  Debit  and  Credit 
items,  for  the  period  under  review,  in  the  Ledger.  The 
total  charges  as  shown  by  the  Day  Book  should  equal  the 
total  charges  as  shown  by  the  Ledger  and  the  total  credits 
of  the  one  should  likewise  equal  the  total  credits  of  the 
other;  special  care,  however,  should  be  taken  to  see  that 
all  accounts  containing  items  referring  to  the  particular 
period  are  included  even  though  the  accounts  are  ruled  up. 

Where  a  single  column  Day  Book  is  used,  it  is  usually 
thought  preferable  to  prove  the  accuracy  of  the  work  by 
checking  back  the  items  in  the  Ledger  to  the  original 
entry  in  the  Day  Book. 

The  Audit  Of. 

The  work  of  an  auditor  has  been  divided  into  three 
classes : 

The  Detection  of  Fraud. 

The  Detection  of  Errors  of  Principle. 

The  Detection  of  Errors  of  Omission. 


SINGLE  ENTRY  9 

In  the  case  of  Single  Entry  Bookkeeping  the  work  is 
accomplished  in  much  the  same  way  as  in  Double  Entry 
— by  verifying  each  item  that  occurs  in  the  books  and  by 
local  ing  and  giving  effect  to  items  that  have  been  omitted. 
Krrors  of  Principle  would  hardly  occur  while  Fraudu- 
lent Errors  could  be  most  easily  covered  and  would  de- 
mand the  utmost  attention  on  the  part  of  the  auditors. 

Statement  of  Affairs. 

Statement  of  Assets  and  Liabilities. 

A  Statement  of  A  Hairs  or  a  Statement  of  Assets  and 
Liabilities  is  a  statement  showing  the  Assets  and  Lia- 
bilities of  a  concern  which  has  not  kept  its  books  on  the 
Double  Kntry  principle.  It  is  prepared,  either  wholly 
or  in  part,  from  outside  sources  and  displays  (he  Present 
Worth  of  the  concern  as  an  amount  representing  the  dif- 
ference between  its  two  sides. 

A  Balance  Sheet  differs  to  the  extent  that  it  is  always 
prepared  from  Double  Entry  I.ooks  and  does  not  con- 
tain, except  probably  as  a  foot  note,  any  items  that  do 
not  appear  in  the  books. 

The  term  "Statement  of  Affairs"  is  also  used  in  ref- 
erence to  a  statement  prepared  to  show  the  probable  value 
of  the  claims  of  the  general  creditors  of  an  insolvent  and 
a  careful  distinction  should  be  made  between  the  Iwo 
forms.  It  is  preferable,  however,  to  always  classify  the 
Statement  of  A  Hairs  of  a  solvent  concern  as  a  Statement 
of  Assets  and  Liabilities  thereby  eliminating  every  pos- 
sibility of  confusion. 

Ascertaining  Profit, 

Resource  and  Liability  Method. 

In  ascertaining  the  profits  for  a  particular  period, 
first  prepare  a  Statement  of  Assets  and  Liabilities  and 


10  ACCOUNTING  PRINCIPLES 

ascertain  the  Net  Worth  or  Propritorship  by  deducting 
the  liabilities  from  the  assets. 

A  comparison  of  this  amount  with  the  Net  Worth  as 
shown  by  the  previous  Statement  of  Assets  and  Liabili- 
ties or  the  Investment  at  the  beginning  of  the  period,  af- 
ter making  due  allowance  for  withdrawals,  will  show  the 
Profit  or  Loss  for  the  period. 

A  portion  of  the  profit  or  loss  resulting  might  be  from 
sources  outside  of  the  business,  such  as  the  profit  re- 
sulting from  the  sale  of  fixed  assets  or  from  outside  in- 
vestments, and  care  should  be  taken  to  see  that  the  busi- 
ness is  not  given  full  credit  and  the  profit  or  loss  on 
ordinary  business  thereby  mis-stated. 

This  plan  of  ascertaining  the  profit  or  loss  of  a  con- 
cern is  known  as  the  Resource  and  Liability  Method ; 
while  the  plan  of  finding  the  Profit  or  Loss  by  the  aid  of 
the  Revenue  Accounts  used  in  Double  Entry  is  classified 
as  the  Loss  and  Gain  Method. 

Preparing  a  Profit  and  Loss  Account. 

Wherever  it  is  desired  to  prepare  a  Profit  and  Loss 
account  displaying  the  sources  of  profit  of  a  concern 
whose  books  have  been  kept  by  Single  Entry,  it  is  neces- 
sary to  tabulate  the  Ledger.  This  is  accomplished  by 
analyzing  each  account  in  the  Ledger  and  tabulating  the 
items  under  appropriate  headings  to  correspond  with  the 
accounts  of  Double  Entry.  After  completing  the  items 
in  the  Ledger,  it  is  necessary  to  bring. into  the  tabula- 
tion all  outstanding  items  covering  Earnings  or  Expen- 
ditures Incurred,  whether  or  not  received  or  paid. 

This  having  been  done  and  the  columns  having  been 
totaled,  the  auditor  is  provided  with  complete  Revenue 
or  other  accounts  and  can  proceed  with  the  preparation 
of  reports  the  same  as  would  have  been  made  from  Dou- 
ble Entry  Books. 


SINGLE  ENTRY  11 

Changing  to  Double  Entry. 

In  changing  a  set  of  books  from  Single  to  Double 
Entry,  it  is  first  necessary  to  prepare  a  Statement  of 
Assets  and  Liabilities,  giving  effect  to  all  items,  whether 
included  in  the  books  or  not.  The  Net  Worth  or  Capital 
of  the  concern  is  also  included  in  the  statement  and  brings 
it  into  Double  Entry  form  by  providing  equal  debits  and 
credits. 

This  gives  a  statement,  the  debit  items  of  which 
equal  the  credit  items.  If  all  of  the  items  are  given  effect 
in  the  Ledger,  the  Ledger  will  also  balance  and  will  be 
in  Double  Entry  form.  It  is,  then,  only  necessary  to  con- 
tinue placing  debits  and  credits  of  equal  amount  to  keep 
the  books  in  this  form. 

In  giving  effect  to  the  items  appearing  in  the  State- 
ment of  Assets  and  Liabilities,  it  is  thought  necessary  to 
provide  a  journal  entry  showing  all  of  the  Assets  as  debits 
and  all  of  the  Liabilities  and  the  Capital  as  credits.  All 
items  that  are  already  in  the  books  are  checked  so  they 
will  not  be  posted  again  and  those  unchecked  are  posted 
to  accounts  appropriately  headed. 


12  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  You  are  asked  to  test  the  correctness  of  a  set  of 
books  kept  by  single  entry  by  applying  the  double  entry 
system  to  the  entries  made.    What  would  you  do  without 
writing  a  new  set  of  books?    Take  as  a  basis  the  follow- 
ing Ledger  accounts: 

Dr.  John  Doe.                                     Or. 

1905  1905 

Jan.    2,  Balance  $1000.     Feb.  2,  Cash                  |  600 

Jan.  20,  Mdse.  500     Feb.  2,  Disc.                        12 

Feb.  2,  Returns  400 

Dr.  Richard  Doe                                   Cr. 

1905  1905 

Jan.  25,  Ft.  Charges  f  200     Jan.  20,  Mdse.               f  2000 

Feb.  2,  Acceptance  1500 

Feb.  2,  Mdse.  Ret'd  300                                     (N.  Y.) 

2.  How  would  you  determine  the  profits  for  a  given 
period  from  a  set  of  books  kept  by  single  entry,  the  cap- 
ital at  the  beginning  of  the  period  being  known?    (N.  Y.) 

3.  How  would  you  audit  a  set  of  Single  Entry  Books, 
and  how  would  you  prepare  therefrom  statements  show- 
ing the  results  obtained  by  the  business?    (Fla.) 

4.  Define   and   differentiate   the   following   kinds   of 
statements : 

(a)  Statement  of  Assets  and  Liabilities. 

(b)  Statement  of  Affairs.     (N.Y.) 

5.  How   would   you    proceed   with   a    Single   Entry 
Ledger,  presuming  that  you  wished  to  prepare  a  report 


SINGLE  ENTRY  13 

showing   Sales.    Freight,    Allowances    for    Returns,   Ex- 
penses, etc.?     (XXX.) 

(}.  Robinson  &  Co.,  wholesale  dealers  in  notions,  whose 
bunks  have  not  been  kept  by  double  entry,  wish  to  improve 
their  system  of  bookkeeping.  Write  a  brief  report,  advo- 
raiing  double  entry,  setting  forth  the  superiority  of  that 
method  generally,  and  showing  by  specific  reference  to 
the  mode  of  bookkeeping  employed  by  them,  the  ad  van 
tages  that  will  accrue  from  the  change.  (N.  Y.) 

7.  Your  suggestion  (see  the  previous  question)  as  to 
a  change  of  method  having  been  approved  by  Robinson  & 
Co.,  you  have  been  instructed  to  make  the  change  at  the 
close  of  the  fiscal  year;  state  in  detail  how  you  would 
proceed  frnm  star!  In  point  of  proof.     (N.  Y.) 

8.  On  Dec.  31,  1907,  the  balance  sheet  of  James  Smith 
&  Co.  showed  liabilities  $1)0,000.00  and  assets  $190,<HM.O<}. 
The  books  are  kept  by  single  entry  and  the  Statement  of 
Assets  and  Liabilities  of  Dec.  31,  1906,  showed  the  cap- 
ital to  be  $98,800.00,  of  which  A's  share  was  $40,000.00; 
P.'s  share  $33,800.00  and  C's  share  $25,000.00.    Profits  as 
follows :    A,  1/2 ;  B,%  ;  C,  %.    During  the  year  "A"  drew 
$5,000.00,  «B"  $4,000.00  and  "C"  $3,000.00.    Make  up  profit 
and  loss  and  partners'  accounts. 

9.  The  Balance  Sheet  of  The  Alameda  Supply  Co., 
Jan.  1,  1907,  shows  the  following  state  of  affairs : 

ASSETS  LIABILITIES 

Real  Estate S50.000.00        Capital  Stock $200,000.00 

Plant  and  Machinery 8.5,000.00        Creditors,  open  account 16,000.00 

and  Wagons. 15,000.00        Bills  Payable 30,000.00 

Patents  and  Goodwill 20,500.00        Profit  and  Loss  Account 30.500XX) 

Inventory 40,000.00 

Accounts  Receivable 35,000.00 

Cash  in  Bank 22,000.00 

$276,500.00  $276.500.00 


A  year  later,  Jan.  1,  1908,  after  an  audit  of  the  books 
and  accounts,  the  Balance  Sheet  stands  as  follows: 


14  ACCOUNTING  PRINCIPLES 


ASSETS  LIABILITIES 

"Real  Estate $52,000.00        Capital  Stock $200,000.00 

Plant  and  Machinery:  Creditors,  open  account 17,000.00 

Bal.  1/1/07 $85,000  Mortgage. 25,000.00 

Less  dep 8,500  Profit  and  Loss  Account: 

76,500.00  Bal.  last  year $30,500 

Horses  and  Wagons:  Profit  this  year 23,400 

Bal.  1/1/07 $15,000  -    53,900.00 

Less  dep 2,250 

12,750.00 

Patents  and  Goodwill 20,500.00 

Inventory 65,000.00 

Accounts  Receivable 33,000.00 

Agency  Investment 15,000.00 

Cash  in  Bank..  .     21,150.00 


$295,900.00  $295,900.00 


From  the  foregoing  it  will  be  seen  that  for  the  year  a 
net  profit  of  $23,400.00  has  been  earned,  while  the  ac- 
sounts  receivable  are  smaller  and  the  cash  balance  on 
hand  is  less  than  at  the  beginning  of  the  year,  though  no 
dividend  has,  in  the  meantime,  been  paid. 

Prepare  an  account  showing  what  has  become  of  the 
profit  earned.  (Lisle),  (N.  Y.),  (Cal.) 

10.  What  procedure  is  necessary  to  change   Single 
Entry  books  into  Double  Entry  books?    Gave  an  example 
using  your  own  figures.     (Pa.) 

11.  H.  Johnson  and  J.  Dinkle  have  been  in  partner- 
ship for  a  year,  the  books  having  been  kept  by  Single 
Entry. 

An  examination  of  their  affairs  discloses  the  follow- 
ing Resources  and  Liabilities:  Goods,  $800.00;  Cash, 
$85.00;  Real  Estate,  $1,000.00;  and  account  due  L.  B. 
Ross,  $900.00;  a  note  in  favor  of  the  firm,  signed  E.  J. 
Jones,  amount  $1,500.00.  Their  investment  was :  Johnson, 
$385.00 ;  Dinkle,  $400.00. 

Prepare  a  statement  showing  the  profit  for  the  year 
and  make  the  Journal  entries  necessary  to  open  new  Dou- 
ble Entry  books.  Also  prepare  the  Capital  accounts  show- 
ing the  disposition  of  the  profit.  (XXX) 

12.  Statement  of  affairs  of  John  Doe,  Jan.  1,  1910. 


SINGLE  ENTRY  15 

Ledger  Balances 

Dr.  Cr. 

M.  C.  Grace «...       $165.00 

Jas.  Hamilton $76.85 

Harold  Wayne 472.65 

J.  B.  Grayson 26.25 

The  Ivy  Press 65.65 

Fredonia  Hotel 67.98 

Mrs.  Chas.  Johnston 176.25 

M.  B.  Johnson 65.65 

Harold  Jackson 345.95 

Jas.  S.  Martin 75.75 

John  Doe,  Investment,  1/1/09 5,000.00 

Resources 

Merchandise,  Inventory $354.50 

Fixtures 450.00 

Cash,  per  cash  book 2,230.55 

Insurance,  Unexpired 10.00 

Accounts  Rec.  as  per  ledger  balances 

Liabilities 

Bills  Payable $90.00 

Accounts  Payable,  as  per  ledger  balances 


From  the  above  information  open  Double  Entry  books 
and  ascertain  the  profit  for  the  period  under  review. 
(XXX) 

13.  John  Smith's  books  show  that  he  has  accounts 
outstanding  to  the  amount  of  f  14,500.00.  They  also  show 
that  he  owes  $7,345.00;  f 2,500.00  of  which  is  a  note  in 
favor  of  his  brother  Harry.  He  estimates  that  his  invest- 
ment was  |5,500.00,  nearly  all  of  which  was  merchandise. 

An  appraiser  estimates  that,  in  addition  to  what  the 
books  show,  he  has  Real  Estate  to  the  amount  of  $9,- 
000.00;  Horses,  $450.00;  Wagons,  $150.00;  Merchandise, 
fi;r>,<)00.00;  Fixtures,  $985.00.  He  owes  the  bank  on  notes 
sir,.(Mi<UH)  and  also  owes  his  brother  $2,000.00  which  does 
not  appear  on  the  books. 

The  Real  Estate  was  purchased  just  prior  to  the  time 
he  entered  business  5  years  ago  and  cost  him  but  $4,500.00. 


16  ACCOUNTING  PRINCIPLES 

From  the  above  information  open  Double  Entry  books 
and  show  the  amount  of  profit  he  has  derived  from  the 
business  during  the  time  he  has  been  in  operation;  .tak- 
ing into  consideration  that  his  living  expenses  amounting 
to  $75.00  per  month,  have  been  taken  from  the  business  in 
lieu  of  salary. 

14.  You  are  asked  to  prepare  an  account  showing  the 
profit  earned  by  a  concern  for  a  certain  period.  The  books 
have  been  kept  by  single  entry  and  you  gather  from  them 
the  following: 

Capital,  $19,360;  Cash,  $2,600;  Accounts  Receivable, 
$15,600 ;  Merchandise,  $10,400 ;  Fixtures,  $1,650 ;  Accounts 
Payable,  $3,850;  Bills  Payable,  $5,000;  Merchandise  used 
by  proprietor,  $800. 

The  Capital  above  set  out  is  the  balance  of  the  ac- 
count after  $1,500  withdrawn  during  the  period  and  $1,200 
for  salary  have  been  charged  up  against  it. 

Set  up  a  statement  showing  the  profit  and  loss.  (N.  Y.) 


CHAPTER  III. 

Accounts  and  Accounting 
Accounts — Character 

Accounts  Defined. 

"An  account  is  a  registry  of  pecuniary  transactions;  a 
written  or  printed  statement  of  business  dealings,  or 
debits  and  credits,  or  of  a  certain  class  of  them,  or  of 
other  things  subject  to  a  reckoning  or  review."  (Web- 
ster. ) 

Accounting  Defined. 

The  act  of  preparing  a  registry  of  pecuniary  transac- 
tions or  of  stating  an  account. 

Accountant  Defined. 

An  accountant  is  one  who  is  skilled  in  designing  and 
preparing  records  of  pecuniary  transactions  and  in  stating 
accounts. 

The  term  Accountant  is  often  assumed  by  bookkeepers 
but  this  application  of  the  term  is  erroneous,  for  account- 
ing implies  much  more  than  more  bookkeeping.  A  refer- 
on «'  to  the  chapter  on  bookkeeping  will  disclose  that  book- 
keeping is  the  act  of  recording  business  transactions — 
the  simple,  mechanical  process.  The  accountant  is  not 
only  able  to  keep  books  but  he  is  able  to  devise  methods 
and  design  the  form  that  books  should  take,  for  the  use 
of  the  bookkeeper.  There  is  also  a  distinction  between 
an  Auditor  and  an  Accountant,  for  Auditing  is  inspecting 
and  criticizing  the  work  of  others.  We  may  therefore 
summarize  as  follows : 


18  ACCOUNTING  PRINCIPLES 

Bookkeeping  is  Mechanical. 

Accounting  is  Constructive  and  Creative. 

Auditing  is  Inspective  and  Critical. 

Certified  Public  Accountant,  Defined. 

A  Certified  Public  Accountant  is  one  who,  by  virtue  of 
his  personality,  knowledge  and  experience,  has  been  able  to 
satisfy  a  board  of  examiners,  acting  for  the  state,  as  to 
his  honesty,  integrity  and  efficiency  in  handling  the  af- 
fairs of  Commerce  and  Finance.  A  person  employing  him 
is  virtually  assured  by  the  state  from  which  he  received 
his  certificate  that  he  is  competent  to  perform  any  work 
pertaining  to  the  profession.  His  certificate  carries  weight 
in  all  financial  institutions  and,  even  though  the  Certified 
Public  Accountant,  himself,  may  be  unknown  to  the  in- 
stitution, the  fact  that  he  has  qualified  and  holds  the 
proper  certificate  is  sufficient  to  assure  the  accuracy  and 
authenticity  of  his  work. 

In  the  case  of  a  Public  Accountant,  who  has  not  qual- 
ified, a  report  prepared  by  him  can  only  be  accepted 
amongst  his  little  circle  of  acquaintances  and  then  only 
after  some  excuse  on  his  part  for  not  possessing  a  C.  P. 
A.  Certificate.  This  excuse  usually  takes  the  form  of  a 
criticism  of  the  examiners  in  the  nature  of  an  assertion 
that  they  are  unfair  to  parties  of  his  experience  and  fear 
the  result  were  he  possessed  of  a  certificate  and  able  to 
compete  with  them.  This  assertion,  however,  is  usually 
entirely  unwarranted ;  in  fact,  the  examiners  often  go  out 
of  their  way  to  have  some  conscientious  and  efficient  ac- 
countant take  the  examination  with  a  view  of  granting 
him  a  certificate  provided  he  proves  competent. 

Their  desire  is  to  build  up  as  strong  an  organization 
as  possible  and,  surely,  this  can  only  be  accomplished  by 
granting  certificates  to  all  really  high  grade  accountants 


ACCOUNTS— CHARACTER  19 

and  by  refusing  to  grant  them,  in  every  case,  where  the 
applicant  is  not  up  to  the  standard,  so  the  public  may 
have  no  trouble  in  discerning  between  the  efficient  and 
those  otherwise. 

Division  of  Accounts. 

It  is  our  desire  to  take  up  the  study  of  the  work  of  an 
accountant,  viz.,  the  devising  of  forms  for  stating  ac- 
counts and  the  propriety  of  including  certain  items  there- 
in. We  believe  it  will  answer  our  purpose  and  will  prove 
more  advantageous  to  the  student  if  we  consider  accounts 
in  the  sense  of  their  being  a  simple  narrative  or  state- 
ment of  facts  or  occurrences,  and  will  not  attempt  to 
classify  them,  as  it  usually  done,  as  simple  Debits  or 
Credits  or  as  to  the  finalty  of  the  record.  We  will  attempt 
to  show  how,  by  using  some  form  that  is  adapted  to  the 
particular  narrative,  it  may  be  more  readily  interpreted ; 
may  insure  greater  accuracy  in  reading  or  transcribing 
or  may  reduce  the  labor  involved  in  classifying  the  events. 
\\V  will  also  attempt  to  show  the  evil  effect  of  careless 
classification,  and  the  advantages  to  be  derived  by  care- 
fully grouping  items  of  a  class,  and  also  by  sub-dividing 
certain  of  these  groups,  carrying  the  important  items  of 
the  group  in  one  account  and  the  minor  items  in  others. 
In  addition  to  this  we  will  show  how  certain  of  the  trans- 
actions may  not  only  be  displayed  individually  but  may 
also  appear  collectively  or  in  summarized  form  with  ad- 
vantage, as  well  as  the  object  of  and  advantages  obtained 
by  so  grouping  them.  First,  though,  we  should  consider 
the  persons  or  things  affected  by  the  transactions,  and  this 
requires  a  classification  as  to  Character. 

Character. 

As  to  Character,  accounts  may  be  Personal  or  Imper- 
sonal. 


20  ACCOUNTING  PRINCIPLES 

Personal. 

Personal  Accounts  are  accounts  with  persons  and  show 
the  effect  of  the  transaction  on  the  various  people  with 
whom  the  institution  has  done  business.  In  its  broadest 
sense,  this  would  include  accounts  with  the  proprietors 
and  we  will  include  the  consideration  of  Proprietorship 
Accounts  under  this  heading. 

Personal  Accounts  with  customers  are  usually  of  such 
an  extensive  nature  that  it  is  desirable  to  keep  them  in  a 
book  or  books  separate  from  the  other  accounts.  They 
are  usually  divided  into  two  sections;  those  to  whom  we 
sell  and  those  from  whom  we  buy.  Each  of  these  sec- 
tions or  groups  may  be  given  a  separate  book  or,  as  is  of- 
ten necessary,  a  number  of  books  may  be  assigned  to  one 
of  the  groups;  for  instance,  the  sales  of  a  large  whole- 
sale house  may  be  divided  as  to  salesmen's  territories  or 
states  covered ;  each  state  or  salesmen's  territory  having 
a  separate  record  or  ledger. 

The  method  of  proving  and  of  incorporating  these 
ledgers  into  the  general  ledger  offers  many  points  of  in- 
terest and  will  be  considered  under  Controlling  Accounts. 

The  accounts  representing  the  Proprietorship  in  a 
concern  may  be  divided  into  three  classes,  representing 
either  the  interest  of  the  individual  operating  alone,  the 
respective  interests  of  partners,  or  the  interest  of  a  col- 
lection of  individuals  operating  as  a  corporation. 

In  the  case  of  an  account  representing  the  proprietary 
interest  of  a  Sole  Trader,  it  is  customary  to  credit  him 
with  his  investment  and  with  any  increases  resulting 
from  his  operations.  Decreases  and  withdrawals  in  the 
nature  of  funds  or  goods  are  charged  to  him.  The  adjust- 
ments to  his  capital  account,  however,  are  made,  usually, 
at  the  end  of  each  fiscal  period;  the  individual  items 


ACCOUNTS— CHARACTER  21 

being  retained  during  the  period  in  a  subsidiary  account 
under  the  heading,  "Drawings." 

In  the  books  of  a  partnership,  accounts  are  operated 
for  each  of  the  partners,  the  same  as  in  the  case  of  a  sole 
trader,  with  the  exception  that  where  partners  have  agreed 
to  invest  a  specific  sum  into  the  undertaking,  their  cap- 
ital account  would  always  show  this  sum  irrespective  of  an 
insufficient  investment,  accruals  in  the  way  of  profits,  or 
deficiencies  representing  losses  sustained. 

To  illustrate:  "A"  and  "B"  have  entered  into  a  part- 
nership agreeing  to  invest  $10,000.00  each  and  to  share 
profits  equally.  "A"  invests  $8,000.00  while  "B"  brings 
in  the  amount  agreed  upon.  There  still  remains  a  liabil- 
ity on  the  part  of  "A"  for  the  $2,000.00  that  he  failed  to 
bring  into  the  firm.  This  should  appear  on  the  books  as 
an  account  against  "A". 

At  the  end  of  a  year,  we  will  suppose  a  profit  of 
$4,000.00  is  ascertained.  "A"  and  "B"  should  each  receive 
credit  for  half  of  this  sum.  In  "A's"  case  this  could  be 
used  to  write  off  his  existing  liability.  While  in  the  case 
of  "B"  the  $2,000.00  would  appear  to  his  credit,  subject 
to  withdrawal. 

Corporations,  as  a  rule,  do  not  carry  any  accounts  in 
their  general  books  with  their  individual  stockholders. 
Exceptions  might  occur  in  the  case  of  a  close  corporation 
but  even  then  it  is  unusual. 

The  customary  plan  is  to  carry  an  auxiliary  record  to 
show  the  shares  held  by  the  individual  stockholders, 
rsually  this  auxiliary  record  is  entirely  separate  from 
any  of  the  financial  books  and  is  operated  entirely  inde- 
pendent of  them.  Even  where  stock  is  only  partly  paid 
for  or  where  dividends  have  been  declared  and  remain 
uncalled  for.  accounts  are  not  opened  for  the  individuals; 
instead,  they  are  treated  as  a  class  and  one  account  an- 


22  ACCOUNTING  PRINCIPLES 

swers  for  them  all.    The  details  of  the  account  being  car- 
ried in  some  other  convenient  form. 

Impersonal. 

Impersonal  Accounts  are  accounts  carried  in  Double 
Entry  books  with  inanimate  things  representing  the  In- 
tegral Units  of  Business.  They  may  be  either  Real,  as 
representing  actual  Property  or  Rights  in  possession,  or 
they  may  be  Nominal,  representing  the  effect  of  each 
transaction  or  class  of  transactions  on  Revenue,  as  Sales, 
Wages,  etc. 


ACCOUNTS— CHARACTER  23 


C.  P.  A.  Questions 

1.  In  centra-distinction  to  the  duties  of  an  Auditor, 
what  are,  generally,  those  of  an  Accountant?    (Cal.) 

2.  Explain  the  following  accounts : 
.  Personal. 

Real. 

Impersonal. 
Nominal.    (Penn.) 

3.  Define : 

(a)  Bookkeeping. 

(b)  Accounting. 

(c)  Auditing, 

and  show  the  relation  of  each  to  the  other.    (Wash.) 

4.  What  advantage  has  a  firm  or  corporation  in  em- 
ploying a  Certified  Public  Accountant  for  the  work  (au- 
diting).   (Wash.) 

5.  Name  the  different  classes  of  accounts.    (R.  I.) 

(I.  "A",  "B"  and  "C"  agree  to  start  in  business  with 
a  capital  of  $400,000.00,  of  which  "A"  is  to  furnish  $200,- 
000.00;  "B",  $100,000.00,  and  "C",  $100,000.00.  "A"  is 
to  have  a  Vi*  interest  in  the  business  and  "B"  and  "C" 
each  14  interest. 

"A"  contributes  $200,000.00 ;  "B",  $90,000.00,  and  "C", 
$80,000.00. 

How  would  the  capital  accounts  appear  on  the  books 
at  the  end  of  the  year?  (Adapted  from  N.  Y.) 

7.  What  is  the  relation  of  nominal  accounts  to  real 
accounts?  How  do  these  accounts  fulfill  the  purpose  for 
which  they  are  created?  (N.  Y.) 


CHAPTER  IV 

Accounts — Form 

We  believe,  for  the  purpose  of  this  book,  it  is  unnec- 
essary for  us  to  explain  the  functions  of  the  Date,  Ex- 
planation, Folio  and  Amount  columns  used  in  separating 
and  classifying  the  various  elements  of  the  usual  business 
transaction  and  that  we  may  start  at  the  point  where 
these  columns  are  grouped  into  a  form  desirable  for  dis- 
playing a  simple  chronological  record  of  transactions  as 
a  class. 

Simple  Chronological  Record. 

Such  a  record  would  contain  the  columns  mentioned 
above,  in  the  order  they  are  given,  and  would  be  desirable 
for  use  in  recording  such  items  as  Cash  Receipts,  etc. 

If  it  were  desired  to  include  the  Cash  Payments  in  the 
same  record,  it  would  be  necessary  to  deduct  each  indi- 
vidual credit  from  the  debits  to  ascertain  the  amount  of 
cash  on  hand  from  day  to  day. 

This  reminds  us  of  the  stubs  of  a  check  book  provided 
with  but  one  amount  column  on  which  a  bookkeeper  had 
endeavored  to  keep  a  record  of  his  bank  account.  He 
started  out  satisfactorily  and  got  the  first  page  correct. 
On  the  second  page,  he  made  an  error  and  immediately 
corrected  it.  On  the  third  or  fourth  page,  he  made  an- 
other error  but  did  not  discover  it  until  the  end  of  the 
month  while  reconciling  his  cash  account ;  then,  in  trying 
to  correct,  he  changed  every  total  or  balance  of  the  fifteen 
pages  that  contained  entries  made  during  the  period  in 
which  the  error  was  undiscovered. 


ACCOUNTS— FORM  25 

The  plan  of  recording  was  very  simple  and  probably, 
owing  to  the  necessity  of  carrying  forward  balances  after 
every  few  items,  was  as  good  as  any  but,  when  it  is  not 
necessary  to  start  a  new  page  after  every  two  or  three 
entries,  it  is  better  to  classify  the  debits  and  credits  and 
provide  a  column  for  each. 

This  can  be  accomplished  by  simply  adding  another 
money  column  to  the  right  of  the  one  already  used  and  by 
entering  the  debits  in  the  first  column  and  the  credits 
in  the  second  one. 

Journal  Form — Debits  and  Credits  Widely  Separated. 

Or,  if  preferable  in  any  particular  case,  instead  of  at- 
taching another  column  on  the  right,  the  additional  col- 
umn could  be  placed  on  the  left  in  the  portion  usually  al- 
lotted to  the  date  but  the  new  column  would  now  contain 
the  debits  and  the  other  the  credits  as  it  is  desirable  to 
always  keep  the  charges  and  credits  on  their  respective 
sides.  An  additional  Folio  column  would  now  be  re- 
quired and  would  be  placed  to  the  right  of  the  new  money 
column  and  between  it  and  the  explanation  column.  The 
date  would  be  inserted  in  the  information  column  between 
each  transaction,  thus : 

Journal,  January,  1911. 
Dr.  Folio  Explanation  Folio       Amount 

1st 
•J4r>.()0          3        Cash 

H.  Watson  27  135.00 

Bills  Rec.  11  110.00 

Pd.  his  a/c  and 
note  in  full 
1st 

The  principal  value  of  this  particular  arrangement  is 
that  the  Debit  and  Credit  items  are  widely  separated  and 


26  ACCOUNTING  PRINCIPLES 

the  danger  of  posting  Debits  as  Credits  or  vice  versa  is 
considerably  reduced. 

Ledger  Form. 
Standard. 

The  a"bove  forms  are  quite  desirable  where  items  occur 
in  chronological  order  and  where  such  chronological  ar- 
rangement assists  in  reference  to  them  but,  where  the 
chronological  arrangement  of  the  events  as  a  class  is 
of  lesser  importance  than  distinguishing  between  the 
Debit  and  Credit  items,  it  is  preferable  to  arrange  two 
separate  and  complete  chronological  records  similar  to 
those  outlined  at  the  beginning  of  this  chapter. 

Each  of  these  records  will  include  columns  for  Date, 
Information,  Keference  and  Amount  and  they  will  be  dis- 
played side  by  side,  the  Debit  on  the  left'  and  the  Credit 
on  the  right. 

The  order  of  the  columns  or  the  amount  of  space  al- 
lotted to  each  is  subject  to  considerable  variation  and  this 
will  require  additional  consideration  on  our  part. 

Ledger  Form  to  Facilitate  Reference 
Between  Debits  and  Credits. 

In  the  case  of  a  Journal,  it  is  usually  considered  ad- 
visable to  show  the  Debit  and  Credit  Money  Columns  as 
widely  separated  as  possible,  or  at  least  to  take  a  con- 
siderable amount  of  precaution  against  posting  one  class 
of  items  as  the  other,  but  in  the  case  of  a  Ledger,  the 
opposite  rule  seems  to  hold  and,  in  general,  it  is  thought 
desirable  to  arrange  these  columns  to  facilitate  reference 
as  much  as  possible. 

One  of  the  best  plans  of  Ledger  rulings,  used  with  this 
end  in  view,  is  that  wherein  the  money  columns  are  placed 


ACCOUNTS— FORM  27 

close  together;  the  date  columns  in  this  case  being  placed 
at  the  edges  of  the  page. 

The  order  of  the  columns  would  be  Date,  Explanation, 
Folio,  Debit  Amounts.,  Credit  Amounts,  Folio,  Explana- 
tion and  Date. 

Ledger  Form — Showing  Balances. 

There  is  also  a  feature,  used  in  connection  with  the 
form  outlined  above,  that  is  rapidly  coming  into  use.  It 
consists  of  placing  between  the  money  columns,  still  an- 
other column  into  which  the  balances  of  the  account  are 
extended.  There  are  a  number  of  derogatory  features, 
however,  which  we  believe  should  be  mentioned  in  con- 
nection with  this  form,  the  principal  one  of  which 
is  the  tendency  of  the  bookkeeper  to  use  only  a 
pencil  when  computing  the  balances  and,  this,  usually  de- 
tracts greatly  from  the  appearance  of  the  books.  It  is  also 
necessary,  if  full  benefit  is  expected  to  be  derived  by  the 
use  of  this  form,  to  start  the  first  entry  for  a  new  month, 
be  it  debit  or  credit  or  even  though  there  are  numerous 
vacant  lines  above,  at  a  point  at  least  one  line  below  the 
balance,  thereby  grouping  all  items  referring  to  a  particu- 
lar month  between  the  balances  as  shown  at  the  begin- 
ning and  end  of  the  period. 

Additional  Columns  for  Monthly  Totals. 

In  the  case  of  a  firm  whose  books  must  show  all  trans- 
actions immediately  after  they  occur,  it  is  sometimes  very 
difficult  to  prove  the  books  owing  to  the  necessity  of  con- 
tinuing with  the  posting  from  day  to  day  even  though 
the  books  are  out  of  balance.  This  difficulty  can  be  elim- 
inated by  using  the  standard  ledger  forms  and  by  adding 
a  money  column  to  the  right  of  each  of  those  already  in 
use;  then  showing  the  total  of  the  debits  and  the  credits, 
either  for  the  current  month  or  to  date,  on  each  of  the 


28  ACCOUNTING  PRINCIPLES 

respective  sides,  in  these  columns.  Additional  entries  can 
then  be  made  without  disturbing  the  work  of  proving  the 
previous  month.  The  "Balance"  form  mentioned  above  is 
also  of  value  in  this  respect  if  properly  operated. 

Detail  Columns. 

Often  in  displaying  an  account  it  is  desirable  to  show 
in  detail  the  items  that  comprise  it. 

This  is  accomplished  by  placing  a  column  to  the  left 
of  the  one  in  which  the  item  to  be  explained  is  shown  and 
showing  in  this  column  all  of  the  items  comprising  the 
total. 

The  most  familiar  example  of  detail  columns  is  the  in- 
voice such  as  is  provided  by  tradesmen  to  show  the  in- 
debtedness for  goods  purchased.  In  this  case,  usually, 
but  one  detail  column  is  necessary,  although  as  many  can 
be  used  as  is  required. 

Combined  Accounts. 

There  are  some  accounts  which  are  so  closely  allied 
that  it  is  desirable  to  display  two  or  more  of  them  in  the 
same  account. 

Take,  for  instance,  income  producing  property- 
stocks,  bonds,  etc.  In  each  case  it  is  desirable  to  distin- 
guish between  the  Income  derived  on  the  Asset  and  any 
increment  or  decrement  that  it  sustains  during  a  par- 
ticular period  and  also  to  retain  all  of  the  items  in  the 
same  account.  This  result  is  obtained  by  carrying  two 
money  columns  on  each  side  of  the  account;  the  first  on 
either  side  being  used  to  record  the  items  relating  to 
Income  and  the  second  to  record  all  other  items.  It  is 
then  possible,  at  a  glance,  to  ascertain  the  income  which 
each  investment  has  produced  as  well  as  the  amount  in- 
vested and  the  nature  of  the  investment,  and,  if  the  Asset 


ACCOUNTS— FORM  29 

has  been  disposed  of,  the  profit  or  loss  resulting  on  the 
transaction. 

Probably  the  most  common  use  of  Combined  Accounts 
is  in  connection  with  the  accounting  of  estates  where 
often  a  very  careful  apportionment  of  Corpus  and  Income 
is  necessary  and  where  the  two  classes  of  items  are  car- 
ried in  separate  columns  throughout  the  books. 

In  the  accounts  pertaining  to  the  issue  and  the  pay- 
ment of  stock  of  a  corporation,  it  is  very  desirable  to 
show  the  number  of  shares  held  by  a  person  as  well  as 
the  amount  he  owes  thereon  in  the  same  account;  there- 
fore, the  two  accounts  are  combined  and  shown  under  the 
one  heading  similar  to  the  illustration  outlined  above. 

Wide  Explanation  Columns. 

We  believe  we  have  fully  covered  the  different  forms 
of  displaying  the  amounts  and  the  dates  and  we  will  now 
take  up  a  study  of  the  Explanation  Columns. 

The  most  common  variation  of  these  is  found  in 
ledgers  where  considerably  more  information  is  required 
in  explaining  one  side  of  the  account  than  in  explaining 
the  other,  for  example : 

In  the  case  of  a  branch  office,  all  invoices  to  the  Home 
Office  would  be  most  fully  explained  in  the  Ledger  to  fa- 
cilitate the  preparation  of  a  statement  of  the  account  to 
forward  the  Home  Office  and  would  require  considerable 
room;  while  the  credits  to  the  Home  Office  Account  in 
the  Branch  Books  would  probably  be  shown  in  total  and 
would  require  no-  explanation  at  all,  except  the  reference 
to  the  page  of  the  Journal  on  which  the  distribution  of 
the  invoices  was  shown.  A  ledger  with  an  exceptionally 
wide  Debit  and  a  narrow  Credit  column  would  conse- 
quently be  preferable  in  this  particular  case. 


30  ACCOUNTING  PRINCIPLES 

Special  Information. 

There  are  also  cases  where  the  utmost  detail  is  re- 
quired in  the  explanation  column,  as  in  the  case  of  a 
brewery,  where  it  is  necessary  to  distinguish  between  the 
charge  for  containers  and  the  charge  for  product;  the 
containers  probably  being  divided  into  a  dozen  different 
sizes  or  styles  and  the  product  into  three  or  four  classes, 
each  of  which  would  require  a  separate  column. 

Leaders. 

In  a  book  as  wide  as  would  be  required  to  contain  the 
number  of  columns  mentioned  above,  it  is  often  hard  to 
follow  a  line  across  the  page. 

Some  of  them  may  be  ruled  in  red  ink — usually  every 
fifth  one — thereby  making  it  very  easy  to  distinguish  be- 
tween the  lines  and  to  follow  the  particular  one  required. 

Proving  Postings. 

The  use  of  additional  columns  may  also  serve  another 
purpose  in  addition  to  giving  a  more  detailed  record  of 
the  transaction,  viz.,  they  may  be  used  to  assist  in  prov- 
ing the  work. 

Folios  Classified. 

By  arranging  additional  reference  columns  to  allow 
one  for  each  book  of  original  entry,  it  is  possible,  although 
possibly  impractical,  to  sort  out  the  amounts  to  which 
they  refer  and  to  classify  them  according  to  the  sources 
of  the  entries ;  then,  in  proving  the  work,  the  total  of  the 
items  posted  to  a  ledger  from  any  book  of  original  entry 
may  be  ascertained  by  totaling  the  items  which  have  an 
entry  in  the  column  that  refers  to  that  particular  book. 
This  total  should  agree  with  the  total  of  the  items  as 
shown  by  the  book  of  original  entry  and  an  error  in  post- 


ACCOUNTS— FORM  31 

ing  could  be  localized  to  one  particular  book  by  a  com- 
parison of  the  amounts. 

Amounts  Classified. 

A  similar  plan  may  be  followed,  in  connection  with 
the  amount  columns,  without  having  recourse  to  the  ref- 
erence columns.  Of  the  two  plans,  the  latter  is  usually 
used  as  it  deals  directly  with  the  amounts  in  question 
and,  thereby,  reduces  the  possibility  of  errors  in  proving. 

Boston  Bank  Ledger. 

The  most  important  use  to  which  this  plan  has  been 
put  is  in  connection  with  the  record  of  depositors'  ac- 
counts in  a  bank.  In  this  particular  case  it  is  essential 
that  the  books  be  balanced  every  day  and  that  they  show, 
at  all  times,  the  exact  status  of  each  account.  In  order  to 
facilitate  the  work,  columns  are  used  for  Balances  at  the 
beginning  of  each  day,  Deposits  made  during  the  day, 
Checks  cashed,  and  Balances  at  close  of  business.  The 
first  column  was  proven  at  the  close  of  business  on  the 
previous  day.  All  deposits  are  entered  in  the  next  column 
and  all  checks  in  the  third  column.  Each  of  these  col- 
umns is  proven  individually  by  making  the  totals  agree 
with  the  total  of  deposit  slips  or  checks  entered.  After 
the  entries  for  the  day  are  known  to  be  correct,  it  is  a 
simple  matter  to  ascertain  the  correct  balance  for  each 
individual  account  and  also  the  total  balances. 

In  ascertaining  the  balance  of  each  account,  it  is  nec- 
essary to  take  the  original  balance,  add  the  deposits  for 
the  day  and  deduct  the  checks;  therefore,  the  totals  of  the 
columns  containing  the  original  balance  and  the  deposits 
should  equal  the  columns  containing  the  checks  and  the 
new  balance. 

If  this  is  true  in  the  case  of  one  account,  it  is  also 


32  ACCOUNTING  PRINCIPLES 

true  of  any  number  of  accounts;  therefore,  all  of  the  ac- 
counts may  be  proven,  en  Woe,  or  any  page  or  section  may 
be  proven  individually  and  an  error,  if  there  is  one,  lo- 
calized to  a  particular  page  or  section  and  later  to  a  par- 
ticular account. 

Membership  Ledger. 

In  the  case  of  Clubs,  Lodges,  Banks,  and  similar  insti- 
tutions, where  there  are  usually  but  few  entries  to  an  ac- 
count between  each  period  of  balancing,  it  is  customary  to 
include  a  considerable  number  of  accounts  to  a  page,  al- 
lowing only  a  few  lines  to  each  one;  each  page  or  section 
is  then  considered  as  one  account  and  treated  accordingly. 

It  is  also  customary  to  dispense  with  the  Explanation 
Columns  entirely  as,  in  general,  the  charges  to  all  ac- 
counts are  similar  and  a  column  is  provided  for  each 
class  of  items  making  it  unnecessary  to  further  explain 
the  transaction.  A  special  column,  usually  on  the  ex 
treme  left,  must,  however,  be  provided  for  the  names  of 
the  accounts. 

As  an  example,  take  a  club  or  a  telephone  company. 
In  each  case  a  charge  is  made  to  each  account  at  a  stated 
period  to  cover  services  for  that  period ;  therefore  special 
columns  are  provided  for  the  names  and  for  each  period's 
charges.  Usually  there  is  a  fine  or  penalty  for  arrears 
and,  in  order  to  facilitate  the  work,  the  books  are  usually 
closed  on  the  day  the  penalty  accrues.  The  balances  due 
on  the  accounts  are  extended  into  a  specially  designated 
column,  and  in  still  another  column  an  amount  is  en- 
tered, after  each  balance  found  in  the  balance  column,  to 
represent  the  penalty.  These  two  items  form  the  nucleus 
of  the  new  month's  accounts. 

If,  as  is  usually  the  case,  additional  charges  are  made 
to  represent  special  services  in  the  nature  of  long  dis- 
tance calls,  etc.,  they  are  kept  in  memorandum  form  un- 


ACCOUNTS— FORM  33 

til  the  end  of  the  period,  when  they  are  entered,  in  totals, 
in  a  column  specially  provided  for  the  purpose. 

Credits  to  accounts  are  also  cared  for  by  the  aid  of 
special  columns. 

Narrow  or  Short  Pages. 

In  the  case  of  banks  in  particular,  new  pages  are  re- 
quired at  very  short  intervals  and,  in  order  to  eliminate 
the  necessity  of  re-writing  the  names  for  each  new  page, 
it  is  customar}7  to  perforate  the  sheets  on  the  perpendic- 
ular line  that  separates  the  names  from  the  amounts; 
then,  instead  of  copying  the  names  onto  each  new  page,  it 
is  only  necessary  to  remove  the  end  of  the  new  sheet  at 
the  perforations  and  thereby  allow  the  original  set  of 
names  to  be  used  in  connection  with  the  money  columns 
on  the  succeeding  page  or  series  of  pages. 

Different  length  pages  may  be  used  wherever  it  is 
necessary  to  carry  the  totals  forward  from  page  to  page 
MI  short  intervals.  In  this  case,  the  first  page  used  at  the 
beginning  of  a  period  will  be  considerably  shorter  than 
the  rest  and  each  succeeding  page  will  be  just  one  line 
longer  than  its  predecessor,  so  that  the  total  of  the  items 
on  any  page  will  never  be  covered  by  the  preceding  page 
and  so  that  the  totals  may  in  turn  be  totaled  without 
turning  the  pages.  Although  this  plan  is  desirable  in 
niMiiy  cases  its  use  is  limited  to  cases  where  not  exceed- 
ing ten  or  twelve  pages  are  to  be  used,  otherwise  the  short 
pages  would  be  too  short  for  any  use. 

It  is  also  possible  to  use  sheets  in  a  loose  leaf  binder 
in  such  a  way  that  the  totals  of  one  page  will  not  be  ob- 
scured by  the  succeeding  page  and  so  the  totals  of  the 
one  may  be  included  in  the  totals  of  the  next  without 
rewriting.  This  is  accomplished  by  cutting  one  line  off 
either  the  top  or  the  bottom  of  every  page  except  the  first 


34  ACCOUNTING  PRINCIPLES 

of  any  particular  period  and  by  using  them  in  such  order 
that  the  totals  of  any  page  will  always  appear  either 
above  or  below  the  next  page. 

When  the  first  page  is  totaled  at  the  bottom,  as  is 
usual,  the  succeeding  page  should  be  one  of  those  Avith 
the  lower  line  removed.  After  it  is  in  place  the  totals 
from  the  first  page  will  remain  in  view  and  may  be  in 
eluded  with  the  items  of  that  page  when  ascertaining 
their  total.  In  this  case,  however,  the  totals  of  these 
pages  must  be  placed  at  the  top  of  the  new  page  so  that 
when  the  third  page  of  the  series,  the  one  with  the  top 
portion  removed,  is  in  place  it  will  still  remain  in  view 
and  may  be  added  with  the  items  on  that  page.  The  totals 
in  this  case  being  placed  at  the  bottom  of  the  sheet.  It 
will  be  noticed  that  the  totals  will  alternately  appear  at 
the  top  of  one  page  and  the  bottom  of  the  next. 


ACCOUNTS— FORM  35 


Questions  for  Written  Work. 

1.  What  advantages  are  to  be  derived  by  widely  sep- 
arating the  Debit  and  Credit  amounts  in  a  journal? 

2.  Distinguish  between  a  journal  and  a  ledger  as  to 
use. 

X.  What  advantage  is  to  be  derived  by  placing  both 
money  columns  together  in  a  ledger? 

4.  Could  the  form  referred  to  in  question  3  be  im- 
proved upon  in  any  way? 

5.  Explain  the  form  used  where  it  is  desirable  to 
maintain  the  sequence  of  dates. 

6.  Outline  three  forms  of  ledger  ruling  each  differing 
from  the  standard  form.    Mention  the  points  of  superior- 
ity over  the  common  form  of  each  of  the  three  special 

forms,  for  the  purpose  intended.  (  N.  Y.),  (111.) 

7.  Rule  a  ledger  for  use  under  the  following  con- 
ditions : 

Allowing  an  easy  comparison  of  amounts, 

An  extra  column  for  balances, 

Considerable  detail  in  explaining  the  debit  entries. 

8.  Prepare  a  Ledger  ruled  in  such  a  way  that  the 
totals  of  each  column  will  represent  the  total  of  one  of 
the  books  of  original  entry. 

!).  Prepare  a  Ledger  for  the  use  of  a  business,  having 
1,000  accounts,  in  which  it  is  necessary  to  know  the  total 
Charges  and  Credits  to  each  Ledger  daily  and  where  it 
is  also  necessary  to  know  the  balance  standing  to  the 
Credit  of  each  account  daily. 

It  is  also  necessary  that  the  balances  be  arranged  in 


36  ACCOUNTING  PRINCIPLES 

such  a  way  that  they  can  be  easily  totaled  and  their  sum 
ascertained. 

There  are  usually  but  few  entries  to  an  account  each 
day. 

10.  Prepare   a   Ledger    for    a   Telephone    Company 
which  makes  monthly  charges  to  account  for  service  and 
also  for  Long  Distance  calls. 

Where  payment  is  not  made  before  the  tenth  of  the 
succeeding  month  an  additional  charge  is  incurred  to 
cover  cost  of  collection,  etc. 

For  convenience,  the  books  are  balanced  on  the  tenth 
of  each  month. 

11.  Prepare  a  Ledger  Kuling  for  a  Brewery,  arranged 
so  that  each  account  will  show  the  number  and  kind  of 
package  and  the  number  of  the  delivery  receipt  which 
in  turn  contains  the  serial  numbers  of  the  packages.   The 
Account  should  also  show  the  charges  made  for  Keg  beer, 
Bottled  beer  and  Packages  separately  as  well  as  the  total 
charges  of  each  shipment. 

The  credits  should  be  divided  to  show  the  credits  on 
packages  separate  from  the  credits  on  beer. 

The  beer  is  bottled  in  two  sizes.  Boxes  are  arranged 
to  hold  a  dozen  of  each  size  and  barrels  are  prepared 
for  export  trade,  each  containing  5  dozen  quarts  or  10 
dozen  pints. 

The  kegs  are  of  three  sizes. 

12.  Prepare  a  Ledger  for  a  Club  which  charges  an 
admission  fee  of  $50.00,  monthly  dues  of  $5.00  and  also 
additional  sums  for  special  privileges.    Fines  are  charged 
to  the  accounts  where  the  members  fail  to  keep  up  their 
dues. 

13.  What  form  of  ledger  would  be  appropriate  for 
an  enterprise  in  wrhich  the  accounts  bear  interest  at  5% 


ACCOUNTS— FORM  37 

per  annum  on  current  transactions?  Illustrate  a  Ledger 
account  in  detail  showing  the  method  of  computing  the 
interest  and  balancing  it  into  principal  semi-annually. 

(111.) 

14.  Illustrate  the  use  of  a  series  of  cut  pages  in  a 
book  of  original  entry.    Each  page  being  one  line  longer 
than  the  preceding  one  used. 

15.  Illustrate  the  use  of  cut  pages  where  the  top 
of  one  and  the  bottom  of  the  next  is  removed. 


CHAPTER  V. 

Classified  Journals 

Under  the  old  system  of  bookkeeping,  it  was  consid- 
ered necessary  to  not  only  make  an  immediate  memoran- 
dum of  the  transaction  but  also,  at  a  more  opportune 
time,  to  re-write  it  showing  the  accounts  and  the  effect 
thereon.  Each  entry  was  considered  individually  and  it 
was  believed  necessary  to  show,  in  the  ledger,  a  chronolo- 
gical record  of  all  transactions  affecting  an  account.  In 
order  to  accomplish  this  result,  it  was  necessary  to  make 
at  least  two  postings  for  each  transaction  and  in  a  bus- 
iness of  any  size  the  system  was  unwieldy  and  expensive. 
Under  the  stress  of  urgent  necessity  various  plans  have 
been  adopted  to  reduce  the  labor  and  expense  involved. 

The  principal  of  these  consists  of  classifying  the  items 
according  to  accounts  affected  and,  instead  of  posting  all 
of  the  items  affecting  an  account  to  the  ledger,  showing 
a  detailed  list  in  the  book  of  original  entry  and  only 
posting  an  amount  representing  the  total  of  the  items,  to 
the  Ledger.  Those  items  which  make  up  the  total,  wrould, 
of  course,  be  posted  individually  to  their  respective  ac- 
counts. 

In  many  cases  the  items  affecting  an  account  are  so 
numerous  that  a  separate  book  should  be  used  for  record- 
ing them,  as  in  the  case  of  Sales,  Purchases,  etc.,  but  in 
other  cases  the  entries  to  an  account  might  not  exceed  a 
dozen  or  so,  in  which  case  a  page  or  so  in  the  Journal 
could  be  allotted  to  the  entries  affecting  each  important 
account  and  the  plan  of  posting  totals  given  effect. 

In  general,  there  is  but  one  posting  made  to  repre- 
sent the  total  of  the  items  entered  in  the  book  or  on  the 


CLASSIFIED  JOURNALS  39 

alloted  pages  for  a  particular  month,  but  in  some  cases 
it  is  desirable  to  further  subdivide  the  items,  in  which 
case,  additional  columns  are  used  and  the  individual 
items  are  distributed  into  these  columns  as  to  sub-ac- 
counts affected. 

Sales  Book. 

For  example,  take  the  case  of  a  merchant  selling  some 
particular  article;  he  would  have  numerous  charges 
to  customers  but  only  one  credit,  viz.,  to  Sales  account, 
and  a  chronological  record  of  these  would  possibly 
answer  his  purpose.  Suppose  he  should  increase  his  line 
or  desire  to  analyze  his  sales  —  let  us  say  into  Machines 
and  Supplies;  it  would  then  be  necessary  to  provide  col- 
umns, under  each  of  these  headings,  into  which  the  items 
up  a  sale  could  be  distributed. 


Tabular  Proof. 

If,  as  is  usual,  the  original  column  representing  the 
total  of  the  sales  was  allowed  to  remain  and  all  items 
making  up  a  sale  were  also  extended  into  the  distribu- 
tion columns,  the  items  in  the  amount  column  on  any 
p:ige  or  series  of  pages  should  equal  the  total  of  the  items 
in  the  other  columns. 

This  is,  probably,  one  of  the  best  examples  of  Tab- 
ular Proof  and  is  mentioned  as  it  is  one  of  the  principal 
advantages  of  Columnar  Books.  It  should  be  used  wher- 
ever possible  in  this  connection. 

Invoice  Book. 

If  a  dealer's  purchases  are  numerous,  he  should  pro- 
vide a  book  for  the  purpose  of  recording  them.  In  some 
cases  this  would  take  the  form  of  a  scrap  book  into  which 
all  incoming  invoices  would  be  pasted.  The  amount 


40  ACCOUNTING  PRINCIPLES 

of  the  invoice  would  be  extended  into  a  column  provided 
for  the  purpose,  and  would  be  posted  to  the  credit  of 
the  personal  account  affected.  The  column  would  be 
totaled  to  ascertain  the  amount  of  purchases  and  this 
sum  would  be  posted  to  "Purchase"  account  and  would 
counterbalance  the  various  credits  to  the  personal  ac- 
counts. 

Purchase  Journals. 

If  he  preferred,  he  could  use  the  Chronological  Jour- 
nal Form  for  recording  these  items,  in  Avhich  case  he 
would  require  columns  for  the  date  of  invoice,  the  name 
of  the  creditor,  the  terms  of  the  invoice,  the  day  it  would 
become  due  and  the  amount. 

If,  as  stated  above,  he  should  decide  to  analyze  his 
sales  it  would  also  be  advisable  to  analyze  his  purchases, 
in  which  case  he  would  require  additional  columns  to  cor- 
respond, into  which  the  distribution  could  be  made. 


CLASSIFIED  JOURNALS  41 


Questions  for  Written  Work 

1.  Prepare  a  Sales  Book  for  the  use  of  a  foundry 
and  machine  company  in  recording  its  sales.     The  fol- 
lowing information  being  required : 

Date  of  Sale,  Folio,  Name  of  Purchaser,  Items  Sold, 
Selling  Price  of  each  item,  Amount  of  Sale. 

2.  Prepare  a  Sales  Book  similar  to  the  above  but 
allowing  in  addition  for  the  distribution  of  the  Sales  into 
sub-accounts  as  follows: 

Foundry  Account. 

Boiler  Account. 

Engine  and  Machine  Account. 

3.  Illustrate  the  Tabular  proving  method  by  the  aid 
of  figures  and  entries  in  the  form  you  have  prepared  in 
answer  to  the  preceding  question. 

4.  Prepare  a  Purchase  Journal  for  use  under  the  fol- 
lowing conditions: 

It  is  required  to  show  Invoice  Number,  Date,  Name 
of  Creditor,  Terms,  Due  Date  and  Amount  of  the  Credit 
to  the  Personal  Account. 

Charges  will  be  distributed  over  Merchandise  Pur- 
chases, Freight,  Trade  Expenses  and  Sundries. 

Folio  Columns  are  to  be  properly  placed  for  easy 
reference. 


CHAPTER  VI. 

Cash  Records 

In  each  of  the  cases  mentioned  in  the  previous  chap 
ter,  some  particular  class  of  items  has  been  removed 
from  an  account  in  the  ledger  and  their  total  substituted ; 
at  most,  only  one  side  of  the  account  has  been  removed 
and  there  would  still  remain  a  number  of  entries  to  the 
account  in  addition  to  those  represented  by  the  totals. 
Other  cases  arise,  however,  where  almost  the  entire  ac- 
count is  taken  from  the  Ledger  as  in  the  case  of  the  Cash 
Account,  where,  if  any  mention  of  the  account  is  made- 
at  all,  it  is  only  to  show  the  total  charges  and  credits  to 
the  account  for  the  period. 

Two  Column  Cash  Book. 

In  this  case,  as  the  entire  account  is  to  be  removed 
and  as  it  is  now  to  appear  in  a  separate  book,  and,  fur- 
thermore, as  the  entries  therein  are  to  be  both  the  orig- 
inal entry  of  the  transaction  and  the  final  entry  of  the 
cash  account,  it  becomes  necessary  to  provide  columns 
for  both  debit  and  credit  entries,  each  of  which  will 
represent  one  side  of  the  Cash  Account. 

When  a  two  column  cash  book  is  used,  it  is  necessary 
to  post  every  item  appearing  on  either  side  of  the  Cash 
Book  to  the  opposite  side  of  some  other  account  in  the 
ledger;  then,  in  order  to  keep  the  ledger  in  balance,  the 


CASH  RECORDS  43 

total  of  the  respective  sides  is  posted  to  the  same  side 
of  the  Cash  Account  in  the  ledger. 

Tabular  Cash  Book. 

The  plan  of  classifying  the  items  and  extending  all  of 
those  in  certain  predetermined  classes  into  separate  col- 
umns and  posting  the  total  of  the  class  instead  of  the 
individual  items,  is  applicable  to  Cash  Books  as  well  as 
to  other  books  of  original  entry  but,  in  the  case  of  Cash 
Books,  the  original  column  is  used  in  connection  with 
miscellaneous  entries  that  might  arise  for  which  no  spe- 
cial column  has  been  provided,  instead  of  as  a  tabular 
proof  column,  although  the  plan  of  tabular  proof  is  ap- 
plicalble  if  desired. 

As  an  example,  let  us  take  the  case  of  a  sole  trader 
whose  cash  receipts  consist  of  payments  made  by  cus- 
tomers, on  account,  and  also  of  cash  received  from  the 
sale  of  merchandise.  His  payments  are  to  people  from 
whom  he  has  made  purchases  on  account  and  also  for 
Kxpenses,  Freight,  Express,  etc.  If  the  two  column  ('ash 
P»ook  were  used,  each  item  would  be  posted  in  detail 
to  its  individual  account  but,  let  us  presume  that  in 
addition  to  the  original  columns,  he  had  provided  col- 
umns into  which  the  Expense,  Freight,  Express  and 
sundry  items  of  a  class  were  entered;  it  would  then 
only  be  necessary  to  post  one  item,  representing  the  total 
of  each  special  column  at  the  end  of  the  period,  instead 
of  the  numerous  items  which  would  be  included  in  that 
total. 

Discounts  in  Cash  Book. 

Let  us  presume,  also,  that  a  number  of  his  customers 
were  in  the  habit  of  discounting  their  bills  and  also  that 


44  ACCOUNTING  PRINCIPLES 

he  discounted  his  bills.  In  this  case  the  cash  involved 
would  be  slightly  less  than  the  amount  of  the  account 
which  it  was  intended  to  pay  and  a  credit  or  charge 
would  be  necessary,  from  some  source,  to  make  up  this 
difference. 

The  entry,  to  adjust,  could  be  made  through  the  Jour- 
nal individually,  or,  if  the  items  were  numerous  and  it 
was  considered  advisable  to  use  the  Journal  for  this 
purpose,  a  page  or  so  could  be  alloted  to  "Discount  Ac- 
count" and  the  plan  of  posting  totals,  as  outlined,  could 
be  used;  in  general,  though,  it  is  considered  advisable  to 
carry  the  Discount  Columns  in  the  cash  book,  either  as 
memorandum  columns  or  as  regular  cash  columns. 

If  they  were  used  as  memorandum  columns,  they 
would  appear  on  the  same  side  of  the  cash  book  as  the 
entry  representing  the  amount  of  the  actual  cash  in- 
volved, and  the  entry  in  the  Cash  Book  proper  would  be 
the  net  amount  received  or  paid  on  an  account. 

All  of  the  items  appearing  in  the  Discount  Columns 
would  be  posted  individually  to  their  respective  accounts 
and  the  total  would  be  posted  to  "Discount  on  Sales"  or 
"Discount  on  Purchases"  as  the  case  might  be. 

The  Discount  Items  would  not  enter  into  considera- 
tion when  balancing  the  Cash  and  would  have  no  con- 
nection with  it;  in  fact,  there  would  be  virtually  three 
separate  and  distinct  accounts  in  the  cash  book,  one  for 
Cash,  debit  and  credit,  one  for  Discount  on  Sales  and 
one  for  Discount  on  Purchases;  each  of  which  would 
be  considered  separately. 

If  it  were  desired  to  reduce  the  number  of  postings 
to  each  of  the  Personal  Accounts  by  making  but  one 


CASH  RECORDS  45 

posting  of  the  gross  amount  instead  of  two  postings — 
one  for  the  Cash  item  and  one  for  the  Discount — it  would 
be  advisable  to  transfer  the  Discount  Columns  to  the  op- 
posite sides  of  the  Cash  Book  and  to  embody  them  in  the 
Cash  Account.  The  entry  covering  a  Cash  Item  and  a 
Discount,  in  this  case,  would  be  a  charge  or  a  credit  to 
Cash  for  the  gross  amount,  with  a  contra-entry  to  the 
same  account  (Cash)  to  adjust  the  difference  between 
the  amount  entered  and  the  actual  amount  of  cash  in- 
volved. 

The  plan  of  carrying  memorandum  columns  and  mak- 
ing two  postings  offers  a  number  of  advantages  which 
more  than  repay  for  the  extra  work  involved. 

From  an  auditor's  standpoint,  the  entering  of  the  net 
amounts  is  preferable  as  it  facilitates  tracing  cash  re- 
ceipts into  the  bank  and  also  as  it  allows  each  personal 
account  in  the  Ledger  to  accurately  display  the  mode  of 
settlement. 

From  a  statistical  standpoint,  the  plan  of  recording 
Gross  Items  on  one  side  and  Deductions  on  the  other,  to 
counterbalance,  is  entirely  incorrect,  as  neither  side  of 
the  Cash  Book  would  accurately  display  the  receipts  or 
disbursements  and  an  attempt  to  use  the  totals  as  such 
would  be  inaccurate  and  misleading. 

Bank  Columns  in  Cash  Book. 

In  the  Cash  Books  just  outlined,  the  bank  was  not 
considered  and  if  any  funds  were  on  deposit  in  a  bank 
the  amount  thereof  would,  necessarily,  be  included  with 
the  cash  in  the  drawer  when  balancing. 

If  it  were  desired  to  distinguish  between  the  propor- 
tion of  cash  avails  which  were  with  bankers  and  the 


46  ACCOUNTING  PRINCIPLES 

amount  in  the  drawer  but  still  not  carry  a  Bank  Account, 
memorandum  columns  could  be  used  on  each  side  of  the 
cash  book  into  which  the  deposits  and  withdrawals  could 
be  recorded,  the  deposits  on  the  debit  side  and  the  with- 
drawals on  the  credit  side.  In  this  case,  the  cash  receipts 
would  be  debited  to  Cash;  but  as  the  cash  drawer  would 
not  be  considered  separately  from  the  bank,  no  credit  to 
Cash  would  be  given  for  funds  deposited ;  likewise  with- 
drawals would  not  be  charged  to  Cash.  This  plan  is  most 
often  found  where  all  receipts  are  deposited  in  the  bank 
and  where  all  payments  are  made  by  check. 

If  it  were  considered  preferable  to  distinguish  be- 
tween the  Cash  and  Bank  items  and  to  carry  separate 
accounts  for  them  in  the  Ledger,  it  would  be  necessary 
to  credit  cash  with  all  deposits  and,  if  the  Cash  Book 
was  still  to  be  used  for  recording  payments  made  by 
check,  to  charge  cash  with  all  withdrawals.  This  would 
necessitate  standard  columns  on  each  side  of  the  Cash 
Book  to  care  for  the  Bank  items. 

Daily  Balance  Book. 

In  the  case  outlined  above,  the  cash  balance  would 
represent  only  the  amount  of  cash  in  the  drawer  and,  in 
order  to  have  a  record  of  the  total  cash  avails,  it  would  be 
necessary  to  provide  some  sort  of  an  auxiliary  record 
which  will  combine  the  Cash  and  the  Bank  items. 

This  record  usually  takes  the  form  of  a  Daily  Balance 
book  into  which  a  complete  record  of  both  the  Cash  and 
the  Bank  items  is  made. 

In  form,  the  book  would  be  ruled  similar  to  the  fol- 
lowing, and  would,  possibly,  be  printed  three  to  the 
page,  allowing  six  forms  to  be  displayed  when  the  book  is 
opened — this  number  answering  for  a  week's  balances. 


CASH  RECORDS  47 


DAILY  CASH  BALANCE  BOOK 1913 

Bank  Balance,  brought  forward  X 

Cash  Balance,  brought  forward  X 

Cash  Receipts: 

X 

X  X 


XXX 

Cash  Payments: 

X 

X 

X  X 

Cash  Avails: 
Bank: 

Balance,  as  above  X 

Deposits  X 

X 

Withdrawals:  X  X 

Cash: 

Checks  X 

Currency  X 

Specie  XXX 


XXX 

In  Chapter  IV  we  outlined  the  disadvantages  resulting 
from  the  use  of  a  chronological  record  of  events  which 
contained  both  additions  and  deductions  and  mentioned 
the  necessity  of  correcting  each  succeeding  total  to  work 
out  an  error  occurring  in  any  previous  portion  of  the 
work. 

In  accounting  to  prevent  fraud,  this  feature  becomes 
of  value  in  connection  with  the  Daily  Cash  Balance  book 
for,  in  correcting  an  error,  made  either  intentionally  or 
otherwise,  it  would  be  necessary  to  correct  not  only  the 
balances  of  a  preceding  report,  if  it  contained  the  error, 
but  also  the  opening  balances  of  the  current  report,  as 
well  as  both  the  opening  and  closing  balances  of  all  in- 
termediate reports,  or  else  give  effect  to  entries  in  the 
(1;ish  Book  to  adjust  the  error.  In  either  case  the  neces- 


48  ACCOUNTING  PRINCIPLES 

sity  of  making  the  adjustment  would  tend  to  reduce  the 
number  of  such  errors. 

Separate  Books  for  Cash  and  Bank. 

In  the  majority  of  businesses  the  cash  receipts  are 
greatly  in  excess  of  the  number  of  cash  payments,  with  the 
result  that,  as  it  is  necessary  to  carry  both  the  receipts 
and  payments  along  together  chronologically,  the  credit 
side  of  the  page  is  seldom  filled  and  the  unused  space  is 
wasted.  There  are  also  very  few  cases  where  a  like  num- 
ber of  columns  are  required  on  each  side  of  the  book  and 
additional  waste  results  here. 

In  order  to  overcome  this  and  also  to  provide  for  an 
increased  number  of  operators  it  is  often  desirable  to 
provide  separate  books  for  the  Cash  and  the  Bank. 

In  this  case  all  receipts  would  be  deposited  in  the 
bank  and  all  payments  would  be  made  by  check;  there- 
fore, but  one  column  would  be  required  to  record  the 
Cash  Credits  and,  in  the  case  of  the  Bank  Record,  only 
one  column  would  be  necessary  for  the  Bank  Debits. 
This  would  eliminate  the  necessity  of  devoting  an  entire 
side  of  a  page  for  these  entries  as  the  extra  column  could, 
usually,  be  easily  included  on  the  same  side,  or,  if  the 
book  would  thereby  become  cumbersome,  it  could  be  fo- 
lioed  instead  of  paged  and  thereby  be  reduced  in  size,  as 
both  sides  of  the  opened  pages  could  be  used  for  the  same 
class  of  entries,  Debits  or  Credits  as  the  case  may  be, 
allowing  but  a  small  margin  on  one  side  or  the  other  into 
which  the  columns  for  the  contra-entries  could  be  placed. 

Check  and  Deposit  Register. 

Wherever  the  plan  of  carrying  two  separate  books  is 
used,  it  is  customary  to  distinguish  the  one  containing 
the  Bank  entries  as  a  Check  Register. 


CASH  RECORDS  49 

This  book  usually  contains,  in  addition  to  the  cus- 
tomary explanation  columns,  memorandum  columns  for 
Deposits  and  Balances  and  standard  columns  for  With- 
drawals as  well  as  all  those  accounts  that  would  have 
been  provided  for  in  the  Cash  Book  under  similar  condi- 
tions. An  Explanation  Column  should  also  be  provided 
for  Check  numbers. 


50  ACCOUNTING  PRINCIPLES 


Questions  for  Written  Work. 

1.  Contrast  the  daybook,  journal  and  ledger  method 
of  bookkeeping  with  some  more  modern  method.   Describe 
the  limitations  of  the  first  mentioned  method  and  show  to 
what  extent,  in  what  manner  and  for  what  reason  it  has 
been  superseded  or  modified  in  modern  accounting  prac 
tice.     (N.  Y.) 

2.  Draft  a  form  of  cash  book  to  be  used  where  all 
receipts   are   deposited   in   bank   and   all   payments   are 
made  by  check.     Illustrate  the  use  of  this  book  by  three 
or  more  entries.     (N.  Y.) 

3.  Describe  several  methods  of  recording  discounts 
on  accounts  as  paid,  avoiding  misstatements  of  receipts 
and  disbursements.     State  the  advantages  or  disadvan- 
tages of  the  methods  proposed.     (N.  Y.) 

4.  Prepare  forms  of  Cash  Books  illustrating  the  use 
of  Discount  Columns,  under  the  following  conditions : 

(a)  Where  it  is  desired  to  post  the  amount  of  cash 
received  and  the  amount  of  the  discount  separate  to  the 
credit  of  the  customer's  account. 

(b)  Where  but  one  posting,  of  the  gross  amount,  is 
all  that  is  required. 

Compare  the  advantages  of  the  two  methods. 

Make  pro  forma  entries  in  each  of  the  forms  you  have 
prepared. 

Prepare  a  statement,  from  the  figures  you  have  used, 
illustrating  the  method  of  balancing  the  cash. 

5.  """"epare  forms  of  Cash  Books  for  use  under  the 
following  conditions: 


CASH  RECORDS  51 

(a)  Where  Bank  Columns  are  carried  in  the  Cash 
Books  but  where,  in  balancing  the  Cash,  the  total  Cash 
on  hand  is  the  difference  between  the  totals  of  the  Cash 
Received  and  the  Cash  Disbursed  columns  and  includes 
the  amount  in  the  bank  as  well  as  that  in  the  drawer. 

(b)  Where  the  entries  relative  to  the  Bank  Account 
are  kept  in  the  Cash  Book  but  where  separate  Ledger 
Accounts  are  kept  for  Cash  and  Bank. 

(c)  Where   the   total    receipts   are   deposited   daily 
and  where  all  disbursements  are  made  by  checks,  illus- 
trating the  use  of  a  Check  Register. 

Make  pro  forma  entries  in  each  of  the  forms  pre- 
pared and  show  by  the  aid  of  a  Daily  Balance  Book  the 
method  of  proving  the  Cash. 


CHAPTER  VII. 
Accounts — Contents 

In  looking  at  accounts  from  the  viewpoint  of  the  rec- 
ord which  they  are  intended  to  contain,  we  find  that 
they  may  be  divided  into  four  classes :  Major,  Subsidiary, 
Summary  and  Collective. 

Major. 

A  Major  Account  is  one  of  the  more  important  ac- 
counts in  a  set  of  books — one  which  contains,  in  some 
form  or  other,  a  record  of  all  of  the  events  that  go  to 
make  up  the  narrative  covering  the  transactions  of  a 
particular  class. 

Subsidiary. 

A  Subsidiary  Account  is  one  which  is  auxiliary  to, 
though  not  necessarily  dependent  upon,  nor  essential  to, 
some  other  account.  They  are  used  to  contain  certain 
items  of  a  class  either  as  a  temporary  account  which 
may  carry  a  more  detailed  record  than  the  main  account, 
or  which  may  be  made  to  adjust  the  major  account  as 
at  the  end  of  a  fiscal  period,  and  which  will  be  closed 
into  that  account  upon  the  expiration  of  the  time  which 
it  was  intended  to  cover,  at  the  beginning  of  the  new 
period,  or  as  soon  as  it  acquires  sufficient  magnitude  to 
warrant  its  closing;  or  as  a  permanent  account  which 
will  contain  some  portion  of  the  main  account  that  may 
have  been  set  aside  for  some  particular  purpose  and 
which  will  be  in  the  nature  of  a  "Rest." 


ACCOUNTS— CONTENTS  53 

It  will  be  noted  that  these  accounts  may  be  either 
current,  in  the  sense  of  being  in  the  course  of  construc- 
tion and  relating  to  the  present  time,  or  may  be  Rest  or 
Deposit  Accounts  awaiting  future  realization  or  dispo- 
sition. The  relation  that  a  subsidiary  account  might  bear 
to  its  Major  Account  also  deserves  mention. 

Adjuncts. 

If  it  is  intended  to  contain  some  particular  portion  of 
the  items  that  might  go  to  make  up  the  Major  Account 
and  is  used  for  the  purpose  of  relieving  the  Major  Ac- 
count of  unnecessary  detail  or  as  a  Rest  Account  await- 
ing the  culmination  of  some  event  it  will  most  likely 
appear  on  the  same  side  of  the  Ledger,  Debit  or  Credit, 
as  the  account  whose  items  it  Contains,  in  which  case 
it  would  be  an  adjunct  to  it. 

Offset. 

If,  however,  it  represented  items  which,  although  prop- 
erly belonging  to  the  Major  Account,  had  not  been  al- 
lowed to  enter  it  on  account  of  a  tendency  to  disturb 
the  value  that  it  was  desired  to  display,  it  would  appear 
on  the  opposite  side  of  the  Ledger,  in  which  case  it  would 
be  an  Offset  to  the  Major  Account  and  would  appear  as 
a  deduction  from  the  Major  Account  at  any  time  it  was 
used  for  statistical  purposes. 

The  point  of  demarcation  between  Major  and  Sub- 
sidiary Accounts  may  not  be  very  clear,  for  a  number  of 
accounts,  although  of  Major  importance  may,  in  a  sense, 
be  subsidiary  to  some  other  account. 

As  an  example,  take  the  accounts  representing  Sales, 
Purchases,  etc.,  these  are  properly  classed  as  Major  Ac- 
counts, still  they  are  Subsidiary  to  the  Trading  Account ; 
however,  the  Trading  Account  being  of  greater  degree 


54  ACCOUNTING  PRINCIPLES 

than  the  Sales  or  Purchase  Accounts  hardly  comes 
under  the  head  "Major  Account."  It  is  more  properly 
classed  as  a  Summary  Account. 

Summary. 

A  Summary  Account  is  one  which  contains  in  con- 
crete form  the  substance  of  other  accounts;  a  concise 
statement  of  facts.  It  is  a  summing  up  of  the  informa- 
tion contained  in  a  number  of  other  accounts  to  display 
some  fact.  It  differs  from  the  Major  Account  in  that, 
although  a  Major  Account  may  likewise  have  accounts 
that  are  Subsidiary  to  it,  the  items  contained  in  the 
Subsidiary  Account  are  of  the  same  degree  as  the  items 
contained  in  the  Major  Account  while,  in  the  case  of  the 
Summary  Account,  the  items  which  it  contains  are  of 
higher  degree  than  the  items  which  go  to  make  up  the 
accounts  which  are  represented  therein. 

Collective. 

Collective  Accounts  are  those  which  gather  a  number 
of  accounts  together  into  an  aggregation.  Their  func- 
tion is  to  enable  the  one  account  to  answer  the  purpose 
of  many. 

The  distinguishing  feature  between  a  Summary  and  a 
Collective  Account  is  that  the  one  takes  a  number  of 
accounts,  each  of  a  different  class  and  by  their  aid  dis- 
plays some  additional  information;  while  the  other  takes 
items,  which  for  the  purpose  they  are  to  be  used,  are  of 
the  same  class  and  simply  combines  them. 

Contents  of  Accounts. 

There  is  also  another  manner  of  classifying  Accounts, 
viz.,  as  to  the  correlation  of  the  items — Mixed  and  In- 
dividual or  Specific. 


ACCOUNTS— CONTENTS  55 

Specific. 

A  Specific  Account  is  one  which  is  precisely  formu- 
lated and  in  which  the  items  are  of  an  exact,  particular 
nature. 

Mixed. 

A  Mixed  Account  is  one  in  which  the  items  therein 
are  of  a  different  or  dissimilar  nature.  They  are  usually 
the  result  of  a  failure  to  carefully  distinguish  between 
the  functions  of  two  or  more  classes  of  items  and  of 
combining  them,  believing  that  they  are  similar.  At  best, 
Mixed  Accounts  are  misleading  and  fallacious,  and  ac- 
countants should  never  allow  them  to  exist.  An  account- 
ant should  work  under  the  policy  that  if  an  account  is 
worth  keeping,  it  is  worth  keeping  well  and  in  all  cases 
should  see  that  account  headings  are  specific  and  that 
separate  accounts  are  provided  for  all  dissimilar  items. 

An  account  may  be  Mixed  or  impure  in  that:  (a)  it 
contains  items  of  two  or  more  classes,  as  in  the  case  of 
Merchandise,  Interest  and  Discount,  Freight  and  Ex- 
press, etc.;  (b)  or  items  are  contained  therein  which 
although  of  the  same  class  are  of  different  degree  and 
would  be  used  differently  should  the  account  be  applied 
to  some  particular  purpose  or  would  perform  different 
functions  than  other  similar  items  contained  in  the  same 
account,  as  in  the  case  of  Machinery  Account,  which  might 
represent  different  classes  of  machinery,  the  depreciation 
on  each  class  being  different;  or,  (c)  the  account  is  dis- 
turbed by  giving  effect  to  certain  elements  which  could 
more  properly  be  set  aside  in  some  other  account  until 
some  more  opportune  time,  as  in  the  case  of  Machinery, 
Plant,  Equipment,  Land  and  Buildings — accounts  which 
are  sometimes  decreased  on  the  books  annually  to  give 
effect  to  depreciation  when,  in  general,  the  asset  should 


56  ACCOUNTING  PRINCIPLES 

remain  on  the  books  at  cost  and  the  depreciation  should 
be  cared  for  by  the  aid  of  an  offset  account;  or,  (d)  the 
heading  of  the  account  is  a  misnomer  as  applied  to  the 
items  contained  in  the  account,  as  is  often  the  case  with 
"Goodwill",  "Treasury  Stock",  etc.,  or,  (e)  one  account 
has  been  used  to  contain  items  of  a  class  which  would 
later  have  to  be  apportioned  over  several  departments,  as 
in  the  case  of  Expense,  Kent,  Insurance,  Heat,  etc. 

The  rule,  that  account  headings  should  be  specific  and 
that  no  account  should  be  allowed  to  exist  which  did  not 
have  a  definite,  easily  determined  purpose  in  the  books 
or  which  was  so  constructed  that  its  function  could  not 
be  ascertained  except  by  an  analysis  of  its  contents, 
should  be  conscientiously  followed. 

Merchandise. 

Keference  to  a  standard  business  college  text  book 
discloses  that  the  Merchandise  Account  is  supposed  to  be 
debited  with: 

Inventory  or  stock  of  goods  on  hand  at  beginning  of 
business. 

Merchandise  purchased. 

Goods  returned  after  being  sold  and  credited  to  mer- 
chandise. 

Shortage,  Damage  or  Overcharge  Claims  allowed  on 
goods  previously  sold. 

Merchandise  Discount. 

Freight  and  Drayage,  Storage,  Insurance  or  other  sim- 
ilar charges. 

It  is  supposed  to  be  credited  with: 

Merchandise  sales. 

Goods  returned  after  having  been  charged  to  Mer- 
chandise Account. 


ACCOUNTS— CONTENTS  57 

Merchandise  taken  from  stock  for  private  use,  do- 
nated or  shipped  on  commission. 

Shortage  or  Damage  Claims  on  Purchases. 
Merchandise  Discounts. 

Insurance  received  for  goods  damaged  or  destroyed. 
Inventory  at  time  of  closing. 

An  analysis  of  the  items  entering  into  this  account 
discloses  at  least  a  half  dozen  classes  each  of  which  could 
more  properly  be  placed  in  some  other  account  under  a 
specific  heading.  As  the  account  is  given,  it  simply  rep- 
resents a  conglomeration  of  figures  from  which  no  accu- 
rate information  of  any  sort  can  be  secured  without  an 
analysis  of  its  component  parts. 

Even  the  profit,  which  it  is  supposed  to  display  after 
the  inclusion  of  the  inventory,  is  not  the  actual  Profit, 
either  Gross  or  Net,  on  Sales  or  on  Trading ;  therefore,  the 
account  can  only  result  in  a  misconception  of  the  out- 
come of  the  business  and  surely  it  should  never  be  used 
by  anyone  who  professes  to  be  skilled  in  the  art  of  ac- 
counting. 

The  component  parts  of  Trading  are  Buying  and  Sell- 
ing, therefore  we  should  have  accounts  to  show  Purchases 
and  Sales  and,  as  there  is  usually  a  stock  on  hand  at 
the  beginning  of  any  fiscal  year  and,  also,  as  this  stock 
does  not  pertain  to  either  Purchases  or  Sales,  we  should 
have  still  another  account  headed  "Inventory,  Jan.  1, 
19 — "  or  some  similar  term,  to  care  for  this  item. 

These  three  elements,  after  giving  effect  to  current 
inventories,  outstanding  invoices,  etc.,  represent  the  out- 
come of  Trading;  therefore,  to  display  the  results  of  the 
efforts  along  that  line  we  should  close  these  accounts  at 
the  end  of  each  period  into  one  account  and  to  properly 
distinguish  this  account,  we  should  call  it  "Trading." 


58  ACCOUNTING  PRINCIPLES 

Interest  and  Discount. 

The  principal  objection  to  the  use  of  the  account  In- 
terest and  Discount  lies  in  the  lack  of  preciseness  in  Ac- 
counting terminology. 

Interest  is  a  charge  made  for  the  use  of  money.  It 
is  usually  computed  at  a  rate  per  cent,  and  may  be  col- 
lected either  in  advance  or  during  the  period  of  the  loan. 
If  collected  in  advance  it  is  usually  termed  Discount. 

So  long  as  the  use  of  the  account  is  restricted  to  the 
above  items  and  its  use  is  understood  to  be  so  restricted, 
no  harm  can  result  for  they  are  each  of  the  "same  nature 
and  in  preparing  a  statement  displaying  the  results  of 
a  business,  would  be  used  in  the  same  manner  and  under 
the  same  headings  or  sub-headings ;  but  suppose  that  In- 
terest charged  to  equalize  partners'  investments  or  Cash 
Discount  taken  by  customers  for  the  prepayment  of  their 
bills,  or  Trade  Discounts,  in  the  nature  of  a  reduction 
in  price  of  articles  sold  to  certain  classes  of  the  trade, 
were  included.  All  of  these  items  are  of  a  different  na- 
ture than  those  outlined  above  and,  as  the  heading  In- 
terest and  Discount  applies  equally  well  to  these  as  to 
the  others,  we  should  eliminate  the  term  from  our  nomen- 
clature and  in  its  stead  substitute  headings  of  a  more 
specific  nature;  furthermore,  as  the  net  result  of  the 
Interest  or  Discount  received  and  given  is  of  minor  im- 
portance and  also  as  the  controlling  factors  that  lead  to 
the  granting  or  the  taking  of  discount  are  somewhat  dif- 
ferent, we  should  distinguish  carefully  between  the 
charges  and  the  credits  and  should  open  separate  ac- 
counts for  each  whenever  necessary. 

The  most  commonly  used  headings  are : 

Interest  and 'Bank  Discount,  Dr. 

Interest  on  Loans,  Cr. 

Interest  on  Bonds  and  Mortgages,  Dr. 


ACCOUNTS— CONTENTS  59 

Cash  Discount  on  Purchases,  Cr. 

Cash  Discount  on  Sales,  Dr. 

Interest  on  Investment  of  Partners,  Dr. 

The  item  Trade  Discount  very  seldom  appears  in 
the  books  as  it  is,  in  general,  simply  a  reduction  in  the 
price  of  an  article  and  is  cared  for  in  connection  with 
the  invoice  on  which  it  occurs. 

Freight  and  Express. 

The  items  going  to  make  up  this  account  might  rep- 
resent charges  for: 

Bringing  stock  to  the  establishment,  an  element  of 
cost. 

Delivering  goods  to  customers,  an  element  of  sales. 

Special  expenditure  made  to  procure  certain  goods  in 
n  short  time;  if  they  are  in  the  nature  of  special  goods, 
an  element  of  sales ;  if  they  are  regular  stock  that  should 
have  been  on  hand,  an  element  of  cost. 

The  use  of  such  an  account  could  only  result  in  a  mis- 
conception of  the  results  obtained  and,  in  its  stead,  such 
accounts  as  the  following  should  be  used: 

Freight  on  Purchases,  In  Freight,  Dr. 

Freight  on  Sales,  Out  Freight,  Cr. 

Express  on  Sales,  Dr.  or  Cr. 

Express  on  Purchases,  Dr. 

Machinery  or  Equipment. 

The  analysis  of  a  Machinery  Account  might  disclose 
items  representing: 

Cost  of  Machinery  and  Equipment,  including  Tools, 
Boilers,  Engines,  Lathes,  etc. 

Repairs  and  Replacements,  which  might  or  might  not 
increase  the  value  of  the  Plant. 

Deductions  for  Depreciation. 


60  ACCOUNTING  PRINCIPLES 

Deductions  for  articles  sold,  either  at  Selling  price. 
Cost  or  Book  value. 

Cost  of  removing  and  setting  up  a  machine  in  some 
other  quarters,  and  Items  of  Expense. 

In  general,  this  account  should  only  contain  the  items 
purchased,  at  cost  price,  including  the  expense  of  making 
ready  for  operations. 

If  the  asset  consists  of  items  on  which  the  rate  of  de- 
preciation should  vary,  separate  accounts  should  be  car- 
ried for  each  class  so  that  the  depreciation  could  be  com- 
puted without  an  analysis  of  the  items  or,  if  conditions 
were  such  that  the  additional  accounts  would  be  imprac- 
tical, an  Equipment  Ledger  could  be  installed  which 
would  contain  the  history  of  every  article  of  equipment, 
including  the  Cost,  Date  of  Purchase,  Repairs,  Depre- 
ciation, and  eventually,  the  disposition  of  the  asset,  its 
selling  price  and  the  difference  between  the  decreased 
value  and  the  book  value  to  close  the  account. 

The  Equipment  Ledger  could  be  balanced  by  adjust- 
ing it  to  correspond  with  its  representative  accounts  in 
the  General  Ledger  as  explained  in  Chapter  XX. 

The  Machinery  Account  should  not  be  disturbed  or 
reduced  by  the  depreciation;  instead  an  account  headed 
"Reserve  for  Depreciation  on  Machinery"  should  be  used 
to  contain  the  allowances  of  this  sort.  (See  Chapter 
XVII.) 

Plant. 

That  which  has  been  said  about  the  Machinery  Account 
applies  with  equal  force  to  the  Plant  Account. 

This  account  is  usually  used  .to  show  collectively  the 
value  of  Machinery,  Tools,  Buildings,  etc.,  in  connection 
with  the  Plant. 

It  is  at  times  used  also  to  cover  up  the  "Water"  due 
to  over-capitalization.  Its  use  in  this  connection  is  to 


ACCOUNTS— CONTENTS  61 

be  regretted  and  should  be  avoided  on  account  of  the 
misconception  of  affairs  which  it  conveys. 

Land  and  Buildings. 

These  items  are  also  dis-similar  in  respect  to  the  de- 
preciation that  occurs  thereon  and  that  which  has  been 
said  about  Machinery  or  Equipment  also  applies  here. 

Goodwill. 

(loodwill  represents  the  value  of  the  connection  or 
reputation  which  a  business  has  acquired  during  its  ex- 
istence up  to  the  time  of  its  disposal.  The  account  should 
never  contain  any  items  except  those  representing  its 
actual  purchase  or  sale  price. 

It  is,  like  the  Plant  Account,  sometimes  erroneously 
or  fraudulently  used  as  a  cloak  for  "Watered  Stock,"  but 
it  is  more  proper  to  use  the  term  "Discount  on  Stock" 
and  to  frankly  state  conditions  as  they  are.  Its  value 
should  never  be  increased  on  the  books  except  upon  the 
acquisition  of  additional  property,  and  then,  only  when 
the  actual  value  of  the  thing  given  exceeds  the  tan- 
gible value  of  the  thing  received.  If  stock  of  the  par 
value  of  $5,000,000.00  and  with  an  actual  value  of  $1,- 
000,000.00  were  exchanged  for  the  assets  of  a  going  con- 
cern which  had  a  tangible  value  of  $800,000.00,  the  Good- 
will would  be  $200,000.00,  not  $4,200,000.00  as  is  often 
stated.  The  additional  $4,000,000.00  actually  represents 
a  discount  on  the  stock  and  should  be  shown  as  such  if  it 
can  possibly  be  arranged  to  do  so. 

The  legal  decisions  on  the  subject  seem  to  uphold  the 
validity  of  exchanges  of  property  for  stock  even  though 
the  intrinsic  value  of  the  one  is  undoubtedly  much  less 
than  the  par  value  of  the  other,  therefore  the  plan  out- 
lined above,  although  desirable,  is  usually  impossible  and 


62  ACCOUNTING  PRINCIPLES 

the  Goodwill  or  Plant  account  must  be  used  to  contain 
the  "Water." 

Treasury  Stock. 

Treasury  Stock,  like  Goodwill,  has  been  sadly  mis- 
used in  many  cases  to  cover  up  the  lack  of  stability  of  a 
number  of  corporations  or  to  give  an  appearance  of 
strength  where  but  normal  conditions  prevailed. 

It  should  only  represent  the  par  value  of  stock  which 
has  actually  been  disposed  of  by  the  company  and  which 
is  later  returned  to  it,  either  as  a  donation  or  on  account 
of  a  forfeiture.  The  term  could  also  be  used  in  connec- 
tion with  stock  actually  purchased,  but  as  it  is,  in  gen 
eral,  illegal  for  a  company  to  purchase  its  own  stock,  it 
is  seldom  used  in  this  manner.  If  stock  were  purchased 
it  would  be  treated  as  an  investment  and  would  appear 
in  the  books  at  cost  with  a  memorandum  as  to  its  par 
value.  The  account  should  never  be  used  to  represent  Un- 
subscribed Stock  or  Unissued  Stock  which  has  been  re- 
served for  future  sale. 

Expense. 

The  use  of  an  Expense  Account  as  a  dumping  ground 
for  all  classes  of  items  is  to  be  deplored  and  whenever 
possible  separate  accounts  should  be  opened  for  every 
individual  class  of  Expense.  If  conditions  are  such  that 
items  arise  which  cannot  be  properly  charged  to  specific 
expense  accounts,  an  account  should  be  opened  and 
headed  "Expenses,  unapportionable  and  unclassified" 
which  would  contain  such  items. 

Bent,  Insurance,  Heat,  etc. 

These  accounts,  although  the  headings  are  sufficiently 
specific  under  ordinary  conditions,  require  subdivision 


ACCOUNTS— CONTENTS  63 

wherever  the  business  is  large  enough  to  have  several  de- 
partments. 

\Vhenever  it  becomes  necessary  to  subdivide  the  ac- 
count, special  care  should  be  devoted  to  having  the  sub- 
head analogous  to  the  matter  which  the  account  is  to 
contain.  Such  headings  as  the  following  are  specific  and 
proper : 

Insurance,  Material. 

Insurance,  Merchandise. 

Insurance,  Plant. 

Rent,  Store, 

Rent,  Office. 


64  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  Define : 
Cash  Discount. 
Trade  Discount.     (111.) 

2.  A  corporation,  located  in  Chicago,  that  has  been 
very  lax  in  its  accounting  methods,  carries  a  freight  ac- 
count into  which  it  charges  all  payments,  of  whatever 
nature,  it  makes  to  railroad  companies;  even  payments 
made  on  the  delivery  of  goods  purchased  F.  O.  B.  Chicago. 
If  called  upon  to  reorganize  their  method  what  sugges- 
tions and  alterations  would  you  make  in  respect  to  this 
subject?     State  your  reasons.     (111.) 

3.  What  is  the  Treasury   Stock  of  a   Corporation? 
(111.) 

4.  Define  Goodwill.     On  what  basis  should  Goodwill 
be  valued?    On  what  grounds,  if  any,  can  an  increase  in 
the  book  value  of  Goodwill  be  justified?     (Wash.) 

5.  Would    an    account    "Investments    and    Treasury 
Stock"  be  proper?    Why?     (XXX.) 

6.  Is  it  proper  to  charge  the  difference  in  the  value 
of  a  business,  excluding  Goodwill,  and  the  purchase  price 
in  stock,  to  Goodwill  account?     (XXX.) 

7.  By  analysis,  the  debit  side  of  merchandise  account 
shows  purchases,  f  60, 000;  returns  to  us,  f 4,000;  entries 
offsetting  errors  in  sale  extensions,  $2,000 ;  trade  discounts 
to  customers,  $13,500 ;  balance  profit,  $27,000 ;  the  credit 
side  shows  sales,  $90,000;  returns  by  us,  $5,000;  allow- 
ances to  us,  $1,500;  inventory  at  close  of  year,  $10,000. 
Suggest  such  changes  in  the  method  of  recording  the  fore- 
going statement  as  would  readily  show   (a)  net  amount 


ACCOUNTS— CONTENTS  65 

of  purchases,  (b)  net  amount  of  sales,  (c)  percentage  of 
profit. 

8.  A  company  has  acquired  at  $90.00  per  share,  100 
shares  of  its  own  capital  stock  of  the  par  value  of  f  100 
per  share.  Its  Balance  Sheet  shows  Treasury  Stock 
|!),0()0.  Is  this  correct?  If  so,  why?  If  not,  state  how 
you  would  adjust  the  books.  (N.  Y.) 


CHAPTER  VIII. 

Individual  or  Specific  Accounts 

The  accountant  should  endeavor  to  use  headings  for 
accounts  which  can  only  be  interpreted  in  one  manner 
and  which  are  so  precisely  formulated  that  only  such 
entries  as  properly  belong  therein  could  possibly  be  in- 
cluded in  the  account.  He  should  avoid  ambiguity  and 
the  use  of  terms  or  names  whose  meanings  have  become 
distorted  or  perverted  in  the  public  mind.  Cases  do 
arise,  however,  where,  owing  to  the  inability  to  supply  a 
better  or  more  accurate  term,  it  becomes  necessary  to 
use  the  one  which  has  been  generally  accepted,  even 
though  that  one  may  be  interpreted  in  other  ways  than 
the  items  making  up  the  account  would  warrant.  In  such 
cases,  the  general  term  should  be  modified  or  restricted 
in  some  way  so  that  the  proper  value  of  the  account  will 
be  apparent;  or,  if  conditions  are  such  that  it  is  not 
practicable  to  restrict  or  modify  the  account  in  the  books 
or  in  the  Balance  Sheet,  special  mention  could  be  made 
of  the  account  in  the  accountant's  report  setting  forth 
the  exact  meaning  of  the  term  as  used. 

The  tendency  of  modern  accounting  is  toward  the 
evolving  of  new  and  specific  accounts  to  take  the  place 
of  such  accounts  as  we  have  classed  as  Mixed  Accounts. 
The  result  is  an  account  for  every  class  of  value  or  every 
element  of  business  effort  which  is  a  factor  in  recording 
its  growth  or  decline. 

The  majority  of  these  have  been  mentioned  in  the  pre 
ceding  chapter  so  it  will  be  necessary  to  now  mention 
only  a  few  of  those  which  possess  special  features. 


INDIVIDUAL  OR  SPECIFIC  ACCOUNTS  67 

Purchases. 

The  Purchase  Account  should  contain  only  those  items 
which  have  been  purchased  for  resale,  with  such  credits 
as  may  be  necessary  through  the  return  of  goods  pur- 
chased or  on  account  of  allowances  in  the  nature  of  trade 
discounts,  damages,  overcharges,  etc.  The  balance  of  this 
account  should  represent  the  net  cost,  exclusive  of  Cash 
Discount,  of  the  goods  purchased. 

At  balancing  time,  care  should  be  taken  to  see  that 
jxtst  dated  invoices  are  given  effect  if  the  goods  have  been 
included  in  the  inventory. 

In-Freight,  although  often  included  in  this  account, 
should  be  shown  separately;  first,  to  keep  the  account 
pure;  secondly,  on  account  of  the  value  of  the  In-Freight 
account  should  it  become  necessary  to  apportion  the 
amount  of  freight  paid  over  the  goods  sold  and  the  in- 
ventory. 

The  Purchase  Account  could  be  divided  into  several 
accounts,  such  as :  Purchases,  Raw  Material ;  Purchases, 
Merchandise ;  Purchases,  Grain ;  Purchases,  Flour,  etc., 
if  it  were  desired  to  segregate  and  record  the  transactions 
of  Manufacturing  establishments  that  also  deal  in  other 
goods  or  of  Trading  concerns  operating  various  depart- 
ments. 
Sales. 

This  account  should  include  all  sales  of  stock  which 
were  purchased  with  a  view  of  such  disposition,  as  well 
as  such  deductions  as  overcharges,  returns,  etc. 

The  balance  of  this  account  should  represent  the  net 
sales  of  the  concern  for  the  period  which  the  account 
covers. 

Sales  of  fixtures  or  other  similar  property,  which  at 
the  time  of  purchase  were  not  intended  to  be  dealt  in 
and  which  were  not  charged  to  Purchase  Account,  should 


68  ACCOUNTING  PRINCIPLES 

not  be  included  in  this  account;  neither  should  Sales  on 
Approval,  Consignments  or  Ventures,  nor  actual  sales 
where  the  goods  are  in  the  process  of  manufacture  but 
not  yet  delivered,  even  though,  as  was  the  case  dis- 
closed by  a  recent  audit,  actually  paid  for  before  the 
specifications  of  the  order  had  been  decided  upon. 

Wherever,  owing  to  the  small  number  of  Consign- 
ment Sales  that  occur  or  for  some  other  cause,  it  is 
deemed  desirable  to  include  such  transactions  in  the 
Sales  Account  instead  of  opening  another  account,  ad- 
justments should  be  made,  at  balancing  time,  to  correct 
the  account.  It  is  believed  better,  however,  to  keep  the 
account  pure  from  the  start  so  that  there  will  be  no 
possible  chance  of  overlooking  these  items  or  of  giving 
incorrect  information. 

Allowances  for  damaged  goods  due  to  contingencies 
and  not  in  the  ordinary  run  of  business,  should  be  shown 
separately,  if  they  run  into  any  considerable  sum,  on  ac- 
count of  the  tendency  to  disturb  the  percentage  of  profit 
on  the  goods  sold, — the  profit  on  turnover  as  it  is  called. 

Gross  Profit. 

In  certain  lines  of  business,  such  as  Real  Estate  or 
Jewelry,  it  is  found  advisable  to  separate  the  sales  ac- 
count into  two  sections;  one  representing  the  cost  of  the 
articles  sold  and  the  other  the  profit  on  the  individual 
transactions.  This  gives  rise  to  the  account  "Gross 
Profit." 

In  order  to  accomplish  this  analysis  of  Sales,  each 
article  or  tract  is  designated  by  a  number  which  acts  as 
an  index  to  some  record  of  the  purchase  of  the  property. 
By  reference  to  the  number  and  later  to  the  record  of 
cost,  the  cost  is  ascertained  and  the  selling  price  can  be 
apportioned  over  Cost  and  Gross  Profit. 

The  apportionment  necessitates  twro  columns  in  any 


INDIVIDUAL  OR  SPECIFIC  ACCOUNTS  69 

book  of  original  entry  into  which  such  sales  are  to  be 
recorded  instead  of  one  as  is  used  where  sales  are  not 
so  treated. 

Inventory. 

The  Inventory  Account  should  be  charged  with  the 
cost  of  all  stock  at  any  particular  balancing  period,  which 
has  been  purchased  with  a  view  of  re-selling. 

A  separate  account  should  be  opened  for  each  inven- 
tory; the  heading  designating  which  one  it  represents,  as 
"Inventory,  June  30th,  1913." 

At  the  end  of  each  fiscal  period  or  at  any  time  it  is 
intended  to  verify  the  profits  of  an  undertaking,  an  in- 
ventory of  the  stock  is  taken  and  the  amount  thereof  is 
credited  to  an  account  headed  "Trading."  The  inven- 
tory account,  representing  the  stock  on  hand  at  the  be- 
ginning of  the  period,  is  closed  into  Trading  Account  also, 
as  well  as  the  Purchase  Account  and  such  other  accounts 
as  represent  a  portion  of  the  cost  of  the  goods  sold.  The 
Trading  Account  then  shows  the  actual  cost  of  the  goods 
turned  over. 

It  will  be  seen  that,  immediately  after  the  inventory 
account  representing  the  stock  at  the  beginning  of  a 
period  is  closed  into  Trading  Account,  another  inven- 
tory account  representing  the  stock  on  hand  at  the  end 
of  the  period  and  likewise  the  beginning  of  the  next 
period  will  take  its  place  so  that  at  all  times  the  books 
will  contain  an  account  or  accounts  to  represent  the 
stock  at  the  beginning  of  the  period  of  operation. 

Where  the  old  style  Merchandise  Account  is  used,  the 
inventory  is  taken  to  adjust  that  account  and  the  bal- 
ance of  the  account  represents  the  Profit  or  Loss;  where 
the  Trading  Account  is  used  the  inventory  is  taken  to 
ascertain  the  actual  cost  of  the  goods  sold — the  value  of 


70  ACCOUNTING  PRINCIPLES 

the  goods  turned  over;  the  difference  between  the  cost  of 
the  goods  turned  over  and  the  selling  price  represents  the 
Gross  Profit. 

Valuing  Stock. 

As  previously  stated,  the  Inventory  Account  should 
be  charged  with  the  cost  of  the  goods  purchased  for  re- 
sale. Special  care  should  be  taken  to  see  that  all  goods 
represented  by  invoices  charged  to  Purchase  Account  are 
inventoried,  whether  they  are  actually  in  stock,  either  at 
the  principal  office  or  in  branches,  or  are  in  transit,  and, 
also,  that  the  cost  of  all  goods  sent  out  on  consignment 
as  well  as  an  allowance  for  freight  on  the  stock  on  hand 
is  considered. 

Often  the  latter  item  is  not  considered,  and  the  en- 
tire amount  of  transportation  paid  is  charged  to  the  cur- 
rent period,  but  where  the  item  assumes  very  large  pro- 
portions, as  it  does  in  the  West,  owing  to  the  lack  of 
transportation  facilities  and  the  distance  from  the  base 
of  supplies,  it  is  undoubtedly  better  to  consider  it  as  an 
increase  in  the  value  of  the  stock,  although  in  general, 
it  is  placed  in  a  separate  account.  Care  should  be  taken, 
however,  to  see  that  only  such  charges  as  actually  enhance 
the  value  are  included;  that  is,  removing  stock  from  one 
store  to  another  should  not  be  considered,  unless  like 
goods  would  actually  cost  more  to  deliver  at  the  second 
store  if  shipped  direct  from  the  base  of  supplies. 

If,  owing  to  a  fluctuation  in  the  value  of  stock,  it 
could  be  purchased  at  a  lesser  price  than  was  actually 
paid  for  it  or  contracted  to  be  paid  for  it,  viz.,  if  the 
market  price  is  less  than  the  cost  price,  or  the  contract 
price  where  the  goods  have  not  been  delivered,  it  is  consid- 
ered by  some  accountants  proper  to  inventory  the  goods 
at  the  market  price  instead  of  the  cost;  their  rule  being 


INDIVIDUAL  OR  SPECIFIC  ACCOUNTS  71 

that  an  inventory  should  be  taken  at  cost  or  market, 
whichever  is  lower.  This  is  hardly  proper,  for  the  Gross 
Profit  on  a  transaction  represents  the  difference  between 
the  actual  cost  and  the  selling  price  irrespective  of 
market  price,  and  any  method  of  ascertaining  the  Gross 
Profit,  except  by  considering  actual  cost  and  selling  price, 
must  be  inaccurate.  If,  however,  the  market  price  is  such 
that  a  loss  will  eventually  result  on  the  sale,  a  portion 
of  the  profits  of  one  year  should  be  reserved  to  protect 
the  next  year  against  this  anticipated  loss. 

In  the  case  of  the  sale  of  an  undertaking  or  upon  the 
dissolution  of  a  partnership,  or  in  fact,  any  case  where 
an  inventory  is  taken  except  with  a  view  of  ascertaining 
profits,  the  cost  price  need  not,  necessarily,  be  used;  but 
if  the  object  of  the  inventory  is  to  ascertain  profits  no 
other  method  of  valuation  can  be  considered  proper. 

Where  an  inventory  is  being  taken  to  ascertain  the 
asset  value  of  the  stock  as  well  as  the  profit  on  an  un- 
dertaking, it  should  be  valued  both  as  to  market  and  as 
to  cost.  The  cost  value  to  be  used  in  the  Trading  Ac- 
count and  the  asset  value  in  the  Balance  Sheet,  the  dif- 
ference in  the  two  values  to  be  adjusted  by  the  aid  of  a 
Reserve  Account. 

In  cases  where  the  stock  on  hand  represents  a  num- 
ber of  purchases  at  different  prices  and  a  considerable 
amount  is  involved,  it  is  not  proper  to  consider  the  last 
price  paid  as  the  proper  price  for  inventory  purposes, 
lost,  owing  to  some  small,  probably  intentional,  purchase 
at  a  high  figure,  the  actual  inventory  value  and  likewise 
the  profits  be  greatly  increased. 

It  is  considered  proper  to  base  the  inventory  valua- 
tion on  the  last  few  purchases,  viz.,  presuming  there  were 
1,000  articles  on  hand  and  the  last  purchases  were  as, 
follows : 


72  ACCOUNTING  PRINCIPLES 

Nov.  1st  400@flO.00 

Dec.  1st  400@f  9.00 

Dec.  20th  400@f  9.50 

the  stock  would  be  apportioned  by  assuming  that  all  of 
the  last  two  purchases  were  on  hand  and  that  the  bal- 
ance of  200  articles  remained  of  the  Nov.  1st  purchase; 
therefore,  the  inventory  would  show  200(?/f  10.00;  400@ 
|9.00  and  400(a:f9.50. 

Often,  owing  to  a  fire,  or  for  some  other  reason,  it  is 
either  impossible  or  impracticable  to  inventory  the  stock, 
but  for  financial  reasons,  an  estimate  of  its  value  may 
be  desired.  This  can  be  secured  if  the  inventory  of  some 
previous  date  is  at  hand  and  if  the  Purchase,  Sales  and 
Percentage  of  Gross  Profit  on  Turnover,  to  date,  is  known. 

The  Sales  Account  contains  the  cost  of  the  goods,  as 
well  as  the  gross  profit,  hence  by  dividing  the  amount  of 
the  sales  by  the  percentage  of  gross  profit  plus  100%  to 
represent  the  cost  of  the  goods  sold,  one  per  cent  of  the 
cost  of  the  goods  sold  will  be  secured.  This  amount  multi- 
plied by  100  will  equal  the  cost  of  the  goods  sold.  The 
original  inventory  plus  the  purchases  less  the  cost  of 
goods  sold  will  represent  the  value  of  stock  on  hand. 

In  the  ordinary  trading  concern,  one  inventory  in- 
cludes the  entire  stock,  but  in  the  case  of  a  manufactur- 
ing concern  or  a  trading  concern  handling  various  classes 
of  goods,  there  are  usually  a  number  of  departments  and 
a  separate  inventory  is  taken  for  each. 

In  the  case  of  a  manufactory,  the  inventories  would 
probably  be  of  Raw  Material,  Partly  Finished  Goods,  Fin- 
ished Goods  and,  in  some  cases,  Merchandise  Purchased. 
Inventory  accounts  should  be  operated  for  each  of  these 
divisions. 


INDIVIDUAL  OR  SPECIFIC  ACCOUNTS  73 

Raw  Material. 

The  inventory  of  raw  material  should  include  every- 
thing which,  during  manufacture,  enters  into  the  finished 
product  but  which  has  not  been  changed  in  form  or  value 
In  the  manufacturer.  It  should  not  include  engine  room 
supplies,  tools  or  repair  parts,  etc.,  neither  should  it  in- 
clude articles  which  enter  into  the  finished  product  with- 
out additional  manufacture,  such  as  completed  parts, 
etc.  These  should  be  inventoried  separately  as  Partly 
Manufactured  Goods. 

The  inventory  value  of  raw  material  should  include, 
in  addition  to  original  cost,  duty  and  infreight,  although 
separate  accounts  could  be  used  to  contain  the  freight  or 
duty  pertaining  to  the  goods  on  hand. 

Partly  Manufactured  Goods. 

The  inventory  of  Partly  Manufactured  Goods  should 
include  all  articles  in  the  process  of  manufacture.  The 
value  should  be  at  actual  cost  of  raw  material  or  parts, 
including  duty  and  in-freight,  plus  labor  and  a  portion 
of  the  overhead  expense  or  on-cost. 

If  the  inventory  is  prepared  for  a  concern  operated 
by  a  Holding  Company,  and  if  a  portion  of  the  goods 
inventoried  are  received  from  some  of  its  subsidiary  com- 
panies, it  is  considered  proper  to  inventory  the  goods  at 
selling  price  to  the  purchasing  company,  but  the  holding 
company  should  set  aside  a  portion  of  its  profits  to  cover 
this  increase  in  value  through  the  transfer  from  one  de- 
partment of  its  organization  to  another.  The  first 
company  would,  undoubtedly,  be  entitled  to  its  profit 
on  the  sale  to  the  other  company,  likewise  the  purchas- 
ing company  should  pay  the  market  value  for  the  articles 
transferred,  but  the  holding  company  could  hardly  as- 
sume a  profit  on  the  simple  transfer. 


74  ACCOUNTING  PRINCIPLES 

Where  goods  are  in  the  process  of  manufacture  and 
are  to  be  sold  at  a  price  which  will  result  in  a  loss,  the 
loss  should  be  anticipated  and  given  effect  in  the  current 
year's  business. 

On  exceptionally  large  contracts  where,  were  the  en- 
tire profits  to  be  given  to  the  year  in  which  delivery  is 
to  be  made,  the  result  would,  be  an  excessive  dividend  in 
that  year  as  against  a  very  small  dividend  in  the  pre- 
ceding year,  and  where  the  contract  is  sufficiently  well 
along  that  the  outside  limit  of  cost  to  complete  can  be 
ascertained  with  a  considerable  degree  of  accuracy,  and 
where  the  contract  will  undoubtedly  result  in  a  profit, 
it  is  considered  proper  to  apportion  the  estimated  profit 
over  the  two  years  on  the  basis  of  the  amount  expended 
to  date  and  cost  to  complete,  to  completed  cost. 

Finished  Goods. 

Inventories  for  Finished  Goods  should  be  on  the  same 
lines  as  outlined  for  Partly  Finished  Goods,  viz.,  Cost 
should  control.  No  estimated  profit  should  be  consid- 
ered, and  any  losses,  due  to  unfavorable  contracts  or 
conditions,  should  be  anticipated  and  cared  for. 

In  the  case  of  partnership  adjustments,  it  is,  at  times, 
considered  proper  to  assume  a  profit  on  manufactured 
goods  but  this  should  be  accomplished  without  disturb 
ing  the  inventory  valuation  at  cost. 

Royalties  on  patents,  capitalized  on  the  theory  that 
the  cost  of  the  goods  would  be  increased  if  the  patent 
were  not  the  property  of-  the  concern  and  if  it  were  neces- 
sary to  pay  the  royalty  to  others,  would  hardly  be  in- 
cluded in  the  cost  of  the  goods ;  in  fact  it  seems  improper 
to  make  such  an  allowance. 

In  general,  the  cost  of  a  patent  is  spread  over  the 
period  of  its  anticipated  active  life  by  a  like  charge 


INDIVIDUAL  OR  SPECIFIC  ACCOUNTS  75 

against  each  year ;  if  desired,  however,  and  if  the  approxi- 
mate quantity  of  product  that  it  will  affect  can  be  ascer- 
tained, it  may  be  spread  over  the  product  per  unit  of  pro- 
duction. In  any  case  the  total  amount  charged  to  Rev- 
enue should  not  exceed  the  actual  cost  of  the  patent  and 
no  profits  should  be  assumed  in  advance  of  actual  sales 
on  account  of  its  possession. 

Obsolete,  uncatalogued  or  deteriorated  goods  should 
be  inventoried  at  cost  price  with  the  other  goods,  but  a 
sum  representing  the  probable  loss  on  this  class  of  stock 
should  be  reserved  to  protect  the  succeeding  year  against 
the  loss  should  it  occur. 

In  making  the  estimate  of  the  proper  amount  to  set 
aside  to  cover  the  loss,  care  should  be  taken  to  see  that 
the  amount  is  based  on  an  actual  appraisal  of  the  goods 
and  not  on  an  arbitrary  percentage  basis  which  may  or 
may  not  be  approximately  correct. 


76  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  Define  Turnover. 

2.  Describe  the  Merchandise  Account  as  it  is  gen- 
erally kept.     Show  how  it  may  be  subdivided,  and  the 
advantages,  if  any,  of  such  subdivision.     (Wash.) 

3.  Purchases,    Sales,   Returns,    and   Allowances    are 
frequently  posted  to  one  account  called  Merchandise.   De 
scribe  the  limitations  of  an  account  so  kept,  and  suggest, 
with  your  reasons  therefor,  an  improved  method  of  re- 
cording these  transactions.      (Mass.) 

4.  How  should  inventories  be  treated  in  closing  the 
ledger  at  the  end  of  a  fiscal  period?   Is  the  common  prac- 
tice of  adding  the  inventory  of  goods  on  hand  to  the 
credit  side  of  the  merchandise  account  theoretically  cor- 
rect?    Explain.     (N.  Y.) 

5.  Acting  as  auditor  of  a  manufacturing  company, 
state  briefly  the  essential  points  to  be  considered  in  as- 
certaining the  correct  profits  so  far  as  inventories  are 
concerned. 

6.  A  manufacturing  concern  finds  that  in  the  past 
fiscal  year  the  prime  or  manufacturing  cost  was  thirty- 
four  per  cent  of  the  profit  on  sales.     On  June  30  of  the 
current  period  the  directors  want  an  approximate  inven- 
tory without  count  or  schedule  and  call  upon  you  to  pre- 
pare   it.      Illustrate   your,  plan    of    procedure — (150-200 
words).     (111.) 

7.  Admitting  that,  in  making  up  an  inventory,  the 
most  approved  method  is  to  value  the  goods  at  cost  price, 
can  you  state  any  instance  where  it  would  be  permis- 
sible to  extend  the  values  at  the  market  price?     (111.) 


INDIVIDUAL  OR  SPECIFIC  ACCOUNTS  77 

8.  Describe   three   methods  of  ascertaining  and   re- 
cording the  profit  or  loss  on  Sales.     (XXX.) 

9.  A  firm  having  several  branches  maintains  an  ac- 
count with  each  branch  in  the  Ledger  and  charges  to 
such  account  all  goods  sent  to  the  agents  for  stock.  When 
stock  is  In  ken  the  balance  of  each  branch  is  treated  as 
ordinary    Accounts   Receivable   and    is    included    in   the 
General  Debts  owing  the  firm.    If  you  see  any  objections 
to  this  method,  state  them,  and  say  how  you  would  deal 
with  the  accounts.    (111.) 

10.  The  East  and  West  Railroad  Company  hauled 
many  tons  of  coal   during  the  year  to  the  various  dis- 
tributing points  along  its  line  for  the  use  of  the  locomo- 
tives, and  upon  this  company  coal  $70,000  freight  was 
charged,  such  charge  being  made  against  the  cost  of  fuel 
for  locomotives  and  credited  to  freight  earnings.     Was 
the  above  method  of  handling  this  freight  item  correct? 
In  answering  state  your  reasons  fully.     (N.  Y.) 

11.  A  trading  and  mining  company  maintains  five 
general  stores  at  five  separate  stations,  and  concentrates 
its  supplies  each  year  at  Station  A,  which  is  the  only 
one   accessible   by   railway;    distribution    is   made   from 
thence  by  means  of  wagon  and  pack  trains.    The  cost  of 
goods  laid  down  at  Station  A  is  10%  above  invoice  prices 
at   the   company's   general   office   in    Montana ;   and   the 
agent  at  Station  A  is  instructed  to  re-bill  all  shipments 
to  Station  B  at  20%  above  original  invoice  cost;  to  Sta- 
tion C  at  35% ;  to  Station  D  at  40%,  and  to  Station  E 
at  50%,  the  experience  of  several  years  bearing  out  the 
General    Manager's   statement   that   such   additions   are 
approximately   correct  and  cover  actual   cost  of  trans- 
portation. 

In  auditing  the  accounts  for  the  purpose  of  certify- 
ing the  annual  balance  sheet,  you  ascertain  that  certain 


78  ACCOUNTING  PRINCIPLES 

goods  at  Station  D  amounting  to  f  10,000,  are  inventoried 
by  the  agent  at  that  point  at  70%  above  the  orginal  in- 
voices which  you  have  examined  at  the  home  office.  He 
states  that  Station  E,  being  overstocked,  shipped  him 
several  lots  of  merchandise  at  price  billed  out  to  E  by 
Station  A,  plus  10%  for  estimated  cost  of  handling  and 
repacking  at  E;  and  to  this  D  legitimately  added  10% 
for  cost  of  transportation  from  E  back  to  D. 

In  your  visit  to  other  stations  you  find  many  similar 
instances  where  goods  have  been  moved  back  and  forth 
and  each  time  the  shipping  station  has  added  10%  for 
handling  and  repacking. 

Out  of  a  total  inventory,  at  all  stations,  of  goods  orig- 
inally costing  |200,000,  the  summary  shows  final  exten- 
sions of  values  aggregating  $325,000,  of  which  not  more 
than  |75,000  is  covered  by  cost  of  transportation,  leav- 
ing |55,000  represented  by  internal  charges  added  be- 
tween the  different  stations. 

Review  the  foregoing  statement  and  give  your  method 
of  handling  such  accounts.  (111.) 

12.  In  the  course  of  trading,  you  make  and  receive 
certain  charges  or  allowances  for  purchased  or  sold  re- 
turned goods.    How  would  you  deal  with  these?     (Penn.) 

13.  A  manufacturing  concern  is  required  to  carry  a 
six  months'  supply  of  a  certain  kind  of  raw  material  and, 
as  the  material  is  not  of  the  kind  that  can  be  purchased 
every  day,  they  must  purchase  it  at  any  time  it  is  offered 
to  them.    For  this  reason  the  prices  fluctuate  sometimes 
very  considerably.     When  they  purchase  this  material, 
they  pay  cash  for  same  and  have  the  material  shipped  in 
as  wanted.     What  method  would  you  use  in  arriving  at 
the  cost  of  this  raw  material  used  during  any  one  month 
in  manufacturing?     (Penn.) 


INDIVIDUAL  OR  SPECIFIC  ACCOUNTS  79 

14.  You  find  that  a  concern  whose  books  you  are 
auditing  has  capitalized  the  amount  of  royalties  that  it 
would  have  had  to  pay  on  the  sales  of  a  three  years' 
period  if  it  had  not  owned  the  patents.    On  the  increase 
of  surplus  thus  obtained  the  directors  have  declared  a 
stock  dividend.     Would  you  consider  yourself  called  on 
to  criticize  the  action  of  the  directors?    If  so,  what  would 
be  the  character  of  your  criticism?     (N.  Y.) 

15.  A  construction  company  contracts  to  erect  build- 
ings or  works,  charging  in  some  instances  a  fixed  price, 
and  in  other  instances  the  actual  cost  plus  a  fixed  per- 
centage thereon.     In  what  manner  should  the  unfinished 
contracts   be   valued   at   the   close   of  each   fiscal   year? 
(Adapted  from  N.  Y.) 

1  (J.  What  should  be  the  procedure  in  ascertaining  the 
value  of  stock  on  hand  at  the  time  of  a  fire;  the  finan- 
cial books  being  intact  and  showing  an  inventory  taken 
four  months  before  the  fire?  It  is  also  possible  to  ascer- 
tain the  Sales  and  the  usual  Gross  Profit.  Without  using 
figures  draft  a  statement  in  the  form  you  would  con- 
sider most  suitable  for  setting  forth  your  findings. 
(Adapted  from  Wash.) 


CHAPTER  IX. 
Cash 

The  Cash  account  should  contain  a  record  of  all  cash 
entering  or  leaving  a  business.  The  balance  of  this  ac- 
count should  represent  the  actual  cash  on  hand,  available 
in  the  liquidation  of  liabilities.  Such  items  as  Certifi- 
cates of  Deposit,  I.  O.  U.'s,  Dishonored  Checks,  or  any 
other  items  that  are  not  actual  cash  or  immediately  con- 
vertible into  cash  should  not  be  included  in  the  balance. 

Statements  of  Receipts  and  Disbursements. 

A  Statement  of  Receipts  and  Payments  or  Disburse- 
ments differs  from  a  Cash  Account  only  in  that  the  be- 
ginning and  ending  balances  are  omitted. 

If  it  is  desired  at  any  time  to  combine  a  Statement 
of  Receipts  and  Disbursements  with  a  Cash  account,  it 
can  be  accomplished  by  arranging  two  sets  of  columns, 
one  for  the  Receipts  and  Disbursements  items  and  the 
other  for  the  Cash  Balances  and  the  totals  from  the  Re 
ceipts  and  Disbursements  columns. 

Statement  of  Revenue  and  Expenses. 
Statement  of  Income  and  Expenditures. 

A  Statement  of  Income  and  Expenditures  should  con- 
tain all  items  of  income  or  expense,  earned  or  incurred, 
whether  or  not  they  have  resulted  in  an  actual  increase  or 
decrease  of  Cash.  In  general,  the  term  is  used  by  so- 
cieties, municipalities  or  similar  institutions,  not  organ- 
ized for  profit,  and  is  intended  to  take  the  place  of  the 
Profit  and  Loss  account  of  a  business  organization. 


CASH  81 

The  principal  difference  between  a  Statement  of  Re- 
ceipts and  Disbursements  and  a  Statement  of  Income  and 
Expenditures  lies  in  that  the  former  may  contain  Capital 
i  i  en  is,  or  Income  items  which  refer  to  some  period  not 
covered  by  the  latter  and  that  the  latter  may  include 
items  which  have  not  yet  been  realized  or  paid.  The 
only  condition  under  which  they  would  both  be  the  same 
would  be  where  there  are  no  Capital  items  included  in 
the  Cash  account  and  where  all  items  of  income  have 
been  actually  paid  or  realized  in  cash.  At  the  winding 
up  of  an  organization  such  statements  could,  possibly, 
be  prepared  to  contain  the  same  items,  provided  that  it 
was  a  non-capital  organization;  otherwise  these  state- 
ments could  not  agree. 

Certificates  of  Deposit. 

A  certificate  of  deposit  represents  actual  cash  depos- 
ited with  a  bank  or  bankers,  either  on  account  of  the  in- 
come it  produces  or  for  safety  where  a  checking  account  is 
not  desired.  In  either  case  it  should  not  be  included  in  the 
cash  balance  but  should  be  placed  in  an  account  headed 

"Certificate  of  Deposit,  maturing ,  19 " 

The  income  it  produces  should  not  be  confused  with  the 
income  derived  from  operations  and,  therefore,  should 
also  be  shown  separately  or  with  other  like  items  in  the 
books. 

Trust  Funds. 

The  legal  liability  of  a  trustee  is  greatly  increased 
where  the  trust  fund  is  not  kept  separate  from  the 
trustee's  own  funds  for,  no  matter  how  careful  he  might 
be  or  how  profitable  an  investment  might  become,  he 
could  not  profit  in  any  way;  whereas,  should  a  loss  re- 
sult under  these  conditions,  even  though  he  was  not  re- 
sponsible for  it  and  had  acted  in  the  best  of  faith,  he 


82  ACCOUNTING  PRINCIPLES 

would  have  to  reimburse  the  estate  to  the  amount  of  the 

loss. 

If  the  trust  funds  are  specifically  invested  or  are  de- 
«  posited  separately  from  his  own,  he  is  only  responsible 
for  mala  fides  acts  and,  for  this  reason,  trust  funds  should 
always  be  separated  from  the  cash  of  the  trustee.  If 
possible  they  should  be  deposited  to  a  separate  account 
in  a  bank  of  good  repute  and  should  be  designated  "Es- 
tate of  Jane  Doe,  Peter  Smith,  Trustee,"  or  some  similar 
term,  specifying  that  the  account  is  that  of  the  estate  to 
distinguish  it  from  the  account  of  the  trustee. 

I.  0.  U.'s. 

I.  O.  U.'s  and  tickets  of  managers  and  other  employees 
form  one  of  the  hardest  problems  of  the  bookkeeper's 
work.  The  managers  usually  feel  that  they  are  privileged 
to  help  themselves  to  the  cash,  often  without  making  a 
memorandum  of  the  amount  taken,  and  other  employees 
easily  acquire  the  habit  of  overdrawing  between  pay  days, 
if  the  opportunity  is  offered.  Everything  possible  should 
be  done  to  discourage  the  practice.  In  the  case  of  minor 
employees,  one  of  the  best  plans  is  to  demand  that  they 
interview  the  manager  and  have  him  vise  the  ticket  be- 
fore making  the  advance.  In  the  case  of  the  manager,  it 
is  probably  better  to  open  an  account  to  which  all  I.  O. 
'U.'s  are  charged  and  then  credit  it  with  his  salary  when 
it  becomes  due,  making  a  check  to  cover  the  difference  in 
his  favor,  if  there  is  any,  at  that  time.  The  tickets 
should  be  retained  until  the  end  of  the  period  and  then 
be  given  him  with  the  check  to  balance  his  salary  ac- 
count. 


CASH  83 


C.  P.  A.  Questions 

1.  Distinguish  between  Revenue  and  Expenditure  Ac- 
count and  Receipts  and  Disbursements  Account.    State 
fully  the  difference.      (N.  Y.) 

2.  State  fully,  reasons  for  or  against  the  use  of  Cash 
Receipts  and  Payments  on  account  of  trading,  as  a  basis 
for  imposition  of  a  tax  on  corporate  incomes.    (N.  Y.) 

3.  Discuss  the  underlying  principles  which  create  a 
distinction  between  a  statement  of  "Receipts  and  Dis- 
bursements"  and   "Revenue   and   Expenses."     Why   are 
the  books  of  most  municipalities  based  upon  Receipts  and 
I  )islmrsements  instead  of  Revenue  and  Expenses?  (Adapt- 
ed from  111.) 

4.  Under  what  conditions  would  the  Receipts  and 
Revenues  and  the  Disbursements  and  Expenses  be  alike? 
(Adapted  from  N.  Y.) 


CHAPTER   X. 

Capital  and  Revenue. 

It  is  believed  advisable,  before  taking  up  the  study  of 
the  various  property  accounts,  to  discuss  the  underlying 
principles  involved  in  distinguishing  between  Capital  and 
Revenue  Income  and  Expenditures. 

Capital  Receipts — More  Properly  Capital  Income. 

Capital  Income  is  that  amount  contributed  to  or  se- 
cured for  permanent  use  by  an  organization  to  enable  it 
to  carry  on  its  business. 

Capital  Expenditures. 

Capital  Expenditures  are  those  expenditures  made  in 
acquiring,  improving  or  extending  the  equipment  of  an 
organization. 

Working  Capital. 

The  Working  Capital  of  an  organization  is  the  amount 
of  the  Capital  Income  remaining  after  caring  for  the  Cap- 
ital Expenditures. 

Fixed  or  Capital  Assets. 

Fixed  Assets  are  those  assets,  acquired  by  Capital 
Expenditures,  which  are  intended  to  remain  in  the  busi- 
ness for  its  use. 

Current  Assets. 
Floating  Assets. 

Current  or  Floating  Assets  are  those  assets,  acquired 
by  the  expenditure  of  Working  Capital,  which  are  not  a 
portion  of  the  permanent  investment  of  the  undertaking. 


CAPITAL  AND  REVENUE  85 

Fixed  Liabilities. 

Fixed  Liabilities  represent  that  portion  of  the  Capital 
Income  of  an  organization  which  is  a  liability  of  the 
concern  as  distinguished  from  the  investment  in  the  or- 
ganization. 

Current  Liabilities. 
Floating  Liabilities. 

Current  or  Floating  Liabilities  are  liabilities  which 
require  attention  within  a  short  time,  viz.,  liabilities 
which  are  not  of  a  permanent  character. 

Revenue  Receipts — More  Properly  Revenue  Income. 

Revenue  Income  is  that  which  properly  arises  from 
the  operation  of  an  undertaking. 

Revenue  Expenditures. 

Revenue  Expenditures  are  those  incurred  in  the  op- 
eration, or  maintenance  of  an  undertaking. 

Capital  and  Revenue. 

In  determining  what  properly  constitutes  an  increase 
in  the  Capital  Assets  of  an  organization,  it  is  necessary 
to  ascertain  the  purpose  and  effect  of  the  expenditure. 

An  expenditure  made  by  an  undertaking  with  a  view 
of  increasing  or  extending  its  operations  or  in  preparing 
it  for  operation  is  a  charge  to  Capital ;  all  others  are  a 
charge  to  Revenue  and  reduce  the  profit  of  the  organi- 
zation. 

In  preparing  a  concern  for  operation,  it  is  presumed 
that  all  expenses  incidental  to  its  organization  or  the 
sale  of  its  stock  or  bonds,  or  in  fact,  every  expenditure  of 
every  nature  up  to  the  time  the  property  is  ready  to  op- 
erate, are  proper  charges  to  Capital. 


86  ACCOUNTING  PRINCIPLES 

Charges  for  increasing  or  extending  the  operations  of 
a  concern  may  properly  include  any  charge  made  for  new 
equipment  which  is  to  be  used  in  addition  to  all  other 
equipment;  or  for  new  equipment  which  is  to  be  used  in 
place  of  some  old  equipment,  in  which  case  the  book 
value  of  the  old  equipment  is  eliminated  from  the  Cap- 
ital Assets  and  the  cost  price  of  the  new  is  substituted; 
or  for  the  residual  value  of  old  equipment  which  has 
been  converted  into  use  again. 

Capital  Assets  should  be  reduced  on  the  books  of  a 
concern  at  any  time  that  a  portion  of  the  assets  are  dis- 
posed of  and  also  from  year  to  year  to  provide  for  de- 
preciation. The  amount  written  off  at  the  time  of  sale 
should  represent  the  book  value  of  the  asset,  viz.,  the 
purchase  price  less  deductions  already  made  or  allowed 
for  depreciation.  The  difference  between  this  sum  and 
the  Selling  Price  should  be  adjusted  through  the  Undi- 
vided Profits  or  Surplus  account  as  affecting  prior  years. 
The  amount  allowed  for  depreciation  from  year  to  year 
should  represent  the  decrease  in  value  of  the  asset  due 
to  wrear  and  tear,  obsolescence  and  effluxion  of  time.  It 
is  in  the  nature  of  a  rental  charge,  paid  by  the  business 
for  the  use  of  the  Fixed  Assets,  and  is  properly  a  charge 
against  Kevenue. 

A  fluctuation  in  the  value  of  the  Fixed  Asset  does  not 
increase  the  rental  value  of  the  asset  to  the  business; 
therefore,  as  the  concern  does  not  intend  to  dispose  of 
the  Fixed  Asset  and  as  it  is  only  intended  for  the  use  of 
the  business,  no  attention  need  be  paid  to  the  fluctuation. 

A  fluctuation  in  the  value  of  a  Current  or  Circulating 
Asset,  which  has,  manifestly,  been  acquired  for  the  pur- 
pose of  realization,  has  a  direct  bearing  on  the  profit  to 
result  from  its  sale  and,  where  a  loss  is  probable,  should 
be  taken  into  consideration  and  the  anticipated  loss  given 


CAPITAL  AND  REVENUE  87 

effect ;  but,  where  the  fluctuation  is  favorable,  it  is  deemed 
better  to  await  the  time  of  sale  before  taking  credit  for 
the  profit. 

Increases  or  decreases  to  Capital  may  also  occur  in 
the  case  of  reversions,  viz.,  where  property  or  a  particular 
sum  of  money  is  to  fall  to  its  owners  at  the  expiration  of 
a  particular  time  and  where  the  income  that  that  person 
or  persons  derive  is  a  sum  different  from  the  true  income 
of  the  property. 

This  principle  applies  in  the  case  of  leaseholds  which 
have  a  rental  value  different  from  the  amount  actually 
received,  but  which  will,  at  the  expiration  of  the  present 
lease,  revert  to  the  owner,  who  will  then  secure  the  greater 
or  lesser  sum,  as  the  case  may  be,  with  the  consequent 
change  in  value. 

The  Revenue  account  is  properly  charged  with  every 
expenditure  incurred  in  the  operation  of  the  business.  It 
should  also  be  charged  for  the  use  of  the  Fixed  Assets 
necessary  to  the  operation  of  the  business  and  for  all 
stores  consumed  as  well  as  with  all  repairs  or  renewals. 

In  general,  every  item  representing  an  expenditure 
which  does  not  actually  enlarge  the  field  of  operations, 
improve  the  fixed  assets  or  increase  the  anticipated  earn- 
ings of  the  concern,  should  be  charged  to  Revenue. 

Although,  prior  to  the  beginning  of  operations,  it  is 
considered  proper  to  include  commission  on  sale  of  stock, 
legal  expenses,  rent,  interest,  etc.,  in  capital,  it  is,  in  no 
case,  proper  to  so  handle  these  items  after  operation  has 
once  begun,  unless  the  expense  is  incurred  in  connec- 
tion with  the  acquisition  of  additional  Capital  Assets. 

It  is  not  to  be  presumed  that  Revenue  Expenditures 
only  include  those  which  do  not  represent  assets,  but 
rather  that,  although  it  includes  all  expense  items,  it 
also  includes  the  expenditures  made  for  assets  which  are 


88  ACCOUNTING  PRINCIPLES 

to  be  immediately  consumed  in  the  business  and  which 
are  of  such  a  nature  that  it  is  not  considered  advisable 
to  record  the  amount  consumed  from  day  to  day. 

Mine  Quarries,  etc. 

The  principles  outlined  above  do  not  apply,  in  prac- 
tice, to  mines,  quarries,  and  similar  undertakings  which 
are  intended  to  operate  only  so  long  as  the  asset  exists. 
Such  organizations  do  not  provide  for  the  reducing  value 
of  the  asset  from  year  to  year  for,  in  general,  it  is  not 
possible  to  replace  it,  neither  is  it  possible  to  ascertain 
the  residual  value  and,  furthermore,  it  is  not  considered 
desirable  to  retain  in  the  business  large  sums  oi'  money 
which  it  is  not  intended  to  re-invest. 

In  such  organizations,  the  investment  and  all  addi- 
tional expenditures  made  in  developing,  promoting  or 
financing  the  concern  are  considered  as  capital  and  all 
receipts  of  whatever  nature,  except  such  as  may  be  neces- 
sary to  maintain  the  equipment  of  the  mine,  are  consid- 
ered as  revenue. 

Companies  intending  to  purchase  other  properties 
and  to  continue  operations  indefinitely  should  provide  for 
depreciation  and  exhaustion  of  properties. 


CAPITAL  AND  REVENUE  89 


C.  P.  A.  Questions 

I.  What  constitutes  Capital  Expenditures?     (Cal.) 
'2.     State  the  general  principles  covering  the  discrim- 
ination between  what  constitutes  proper  charges  against 
capital  and  what  constitutes  proper  charges  against  rev- 
enue. 

3.  Name  and  define  two  classes  of  receipts  (income) 
and  two  classes  of  expenditures.     (R.  I.) 

4.  Under  what  conditions  would  amounts  be  charged 
to  betterments  at  one  time,  and  charged  to  operating  ex- 
penses at  a  later  date  in  railroad,  electric  and  gas  com- 
panies?    (Penn.) 

5.  Point  out  carefully  and  illustrate  with  examples 
the  distinction   that  is  drawn  between   circulating  and 
fixed  capital.    How  far  is  this  distinction  of  importance? 
(Penn.) 

G.  What  effect,  if  any,  has  the  depreciation  of  fixed 
assets  on  the  loss  and  gain  account?  Explain  fully. 
(Penn.) 

7.  Define  your  understanding  of  the  principles  in- 
volved in  determining  what  are  and  what  are  not  expen- 
ditures upon  Capital.     (111.) 

8.  Distinguish  between  depreciation  and  the  fluctua- 
tion of  assets.     (XXX.) 

0.     Do  Revenue  Expenditures  create  assets?     (XXX.) 
10.     Distinguish  between  Revenue  Expenditures  and 
Capital  Expenditures.     (XXX.) 

II.  Where  and  in  what  manner  of  entry  should  rec- 
ord be  made  of  sales  of  plant  and  items  of  machinery  dis- 
posed of  because  worn  out  or  otherwise  useless?     (N.  Y.) 


CHAPTER  XL 

Investments 

A  separate  account  should  be  opened  for  each  invest- 
ment made.  If  it  is  an  investment  of  funds  which  have 
been  reserved  for  some  specific  purpose,  as  in  the  case  of 
a  Sinking  Fund  Investment  or  Reserve  Fund  Investment, 
to  provide  for  Contingencies,  special  mention  should  be 
made  of  the  fact.  In  the  case  of  bonds  or  other  interest 
bearing  securities,  it  is  desirable  to  mention  the  date  of 
their  maturity  as  well  as  the  rate  of  interest  they  bear 
and  the  dates  of  payment  and,  in  the  case  of  stock,  to 
show  the  dividend  dates. 

Accounts  should  be  maintained  to  care  for  the  income 
of  the  investments  either  entirely  separate  from  the  in- 
vestment account  or  by  preparing  an  extra  set  of  col- 
umns, debit  and  credit,  under  the  same  heading,  form- 
ing a  combined  account  as  outlined  in  Chapter  IV. 

Investments  in  Real  Estate. 

The  treatment  of  an  account  representing  Real  Estate 
held  as  an  investment  differs  considerably  from  that  rep- 
resenting the  acquisition  of  property  for  the  use  of  the 
concern.  In  the  latter  case  no  fluctuation  in  the  value  of 
the  propert}^  need  be  considered  so  long  as  the  property 
answers  the  purpose  of  the  business ;  whereas,  in  the  case 
of  an  investment,  an  unfavorable  fluctuation  due  to  a 
change  in  transportation  facilities,  market  conditions, 
etc.,  should  be  given  effect  if  there  is  a  possibility  of  it 
ultimately  resulting  in  a  loss.  The  treatment  of  Real 
Estate  held  as  an  investment  is  much  the  same  as  that 
of  stock  or  other  similar  assets  in  that  no  profit  should 


INVESTMENTS  91 

be  taken  until  the  property  has  actually  been  disposed 
of  and  that  all  losses  should  be  anticipated  and  given 
effect  to  protect  the  year  in  which* the  ultimate  sale  oc- 
curs against  the  year  in  which  the  loss  arises. 

There  is  also  another  principle  which  requires  con- 
sideration in  connection  with  the  Real  Estate  held  as  an 
investment  and  that  is  the  distinguishment  between  Cap- 
ital and  Revenue  Expenditures.  Assessments  for  im- 
provements or  improvements  made  directly  by  the  owner 
undoubtedly  increase  the  value  of  the  property  and  may 
correctly  be  added  to  the  Investment  Account;  but  taxes 
do  not  increase  the  value  of  the  property  and,  in  the  case 
of  producing  property,  should  be  paid  out  of  the  revenue 
they  produce,  the  balance  of  the  revenue,  if  the  asset  is 
held  as  an  investment,  being  a  credit  to  Net  Profits  Ac- 
count. If,,  however,  the  asset  may  be  classed  as  non- 
producing,  in  that  it  produces  no  revenue  or  not  suffi- 
cient to  pay  the  taxes  and  necessary  expenses  incidental 
thereto,  it  is  proper  to  increase  the  amount  of  the  in- 
vestment by  the  amount  which  the  expenses  exceed  the 
income.  This  assertion  is  based  on  the  theory  that  any 
expense  properly  chargeable  to  the  period  of  construction 
or  during  the  time  an  asset  is  being  brought  up  to  a 
producing  stage  is  properly  chargeable  to  Capital.  The 
theory  is  applied  to  mines  in  distinguishing  between  de- 
velopment work  and  operation ;  to  railroads  to  distin- 
guish between  construction  and  operation  and  to  non 
producing  real  estate,  as  stated  above. 

Investments  in  Stocks. 

An  investment  in  the  stock  of  other  companies  may 
be  made  either  to  secure  the  control  of  the  other  organi- 
zation or  on  account  of  the  revenue  it  produces.  If  the 
investment  is  to  secure  the  control  of  the  subsidiary  com- 


92  ACCOUNTING  PRINCIPLES 

pany  the  stock  should  be  entered  on  the  books  of  the  hold- 
ing company  at  its  book  value  and  any  difference  between 
the  purchase  price  and  its  book  value  should  be  set  aside 
in  a  subsidiary  account  until  such  time  as  the  stock  is 
disposed  of.  The  reason  for  placing  it  on  the  books  at 
the  book  value  is  to  facilitate  the  consolidation  of  the 
balance  sheets  of  the  respective  companies,  and  the  separ- 
ation of  the  earned  surplus  from  the  purchased  surplus. 
This  is  accomplished  by  combining  the  figures  of  all  the 
balance  sheets  after  eliminating  or  adjusting  inter-com- 
pany transactions.  If  the  stock  in  the  holding  company's 
balance  sheet  appears  at  the  same  value  as  it  does  in  the 
books  of  the  subsidiary  company,  it  is  only  necessary  to 
offset  the  one  against  the  other.  Any  difference  in  the 
book  value  after  making  due  allowance  for  that  portion 
owned  by  other  stockholders,  will  represent  the  profit  or 
loss  on  the  investment. 

The  holding  company  has  not  purchased  the  stock  of 
the  subsidiary  company  with  a  view  of  re-selling  it,  and 
it  is  in  the  nature  of  a  permanent  investment,  therefore 
no  effect  need  be  given  unfavorable  fluctuations  in  the 
market  value  of  the  stock,  neither  should  a  profit  be  as- 
sumed on  account  of  a  favorable  fluctuation. 

If  the  stock  has  been  purchased,  only  for  the  revenue 
it  produces,  it  should  be  valued  as  other  assets  in  wrhich 
the  firm  deals,  as  outlined  in  Chapter  VIII. 

If  the  stock  represents  the  investment  in  some  mining 
company  or  similar  concern  operating  a  wasting  asset 
which  is  not  maintained  by  reserves,  the  dividends  re- 
ceived will  comprise  a  portion  of  the  investment  that  is 
being  returned  as  well  as  the  actual  profit  on  the  invest- 
ment. It  is  impossible  to  determine,  accurately,  just  what 
portion  of  profit  or  of  capital  the  dividends  contain  and 
it  is  also  manifestly  impossible  for  the  dividend  to  con- 


INVESTMENTS  93 

tinue  to  be  paid  indefinitely,  therefore  some  provision 
must  be  made  which  will  reduce  the  asset  value  of  the 
investment  on  the  books  to  almost  extinction  before  the 
mine  or  other  property  is  exhausted. 

The  rule  of  reducing  the  book  value  to  the  market 
value  whenever  the  market  value  becomes  the  lower  wrould 
hardly  provide  sufficiently  or  properly  for  the  wasting  of 
the  asset,  as,  so  long  as  the  property  produced,  the  amount 
of  the  dividend  would  be  the  criterion  of  value,  rather 
than  the  possibility  of  exhaustion ;  therefore,  some  other 
plan  must  be  used  to  care  for  the  reducing  value  of  the 
investment. 

Whatever  plan  is  used,  it  should  be  one  which  will 
not  actually  extinguish  the  asset  from  the  books,  lest  it 
entirely  disappear  and  its  earnings  be  misappropriated. 
The  plan  of  writing  off  an  amount  each  year  equal  to  the 
net  receipts,  after  allowing  a  fair  rate  of  interest  as  rev- 
enue, is  to  be  recommended.  Of  course,  after  the  asset 
is  reduced  to  a  nominal  sum,  no  further  provision  need 
be  made  for  exhaustion  and  the  entire  dividend  may  be 
treated  as  revenue. 

Investments  in  Bonds. 

An  investment  in  bonds  differs  from  an  investment 
in  stock  to  the  extent  that,  with  the  former,  it  is  gen- 
erally possible  to  ascertain  the  date  at  which  it  will  ma- 
ture, the  actual  amount  to  be  received  as  interest,  the 
amount  the  investment  will  yield  as  income  and  the  rate 
of  the  yield. 

This  is  not  true  of  stocks,  therefore  that  which  has 
been  said  relative  to  investments  in  stocks  will  not  apply. 

In  the  case  of  bonds,  the  purchase  price  is  rarely  par, 
although,  in  general,  they  are  payable  at  par,  therefore 
the  purchase  price  must  be  increased  or  decreased  on  the 


94  ACCOUNTING  PRINCIPLES 

books  from  period  to  period  so  that  its  resultant  balance 
will  equal  the  face  of  the  bond  at  the  time  it  matures. 

If  a  bond  was  purchased  at  a  sum  above  par  and  if 
the  account  remained  on  the  books  during  the  entire  life 
of  the  bond  without  change,  when  the  bond  was  paid,  it 
would  produce  a  considerably  smaller  sum  than  the  book 
value  and  a  loss  would  result  which  would  have  to  be 
adjusted  in  that  particular  year;  inversely,  if  it  had 
been  purchased  considerably  below  par,  a  considerable 
profit  would  have  resulted. 

It  is,  therefore,  self  evident  that  any  income  produced 
by  a  bond  which  was  purchased  above  par,  should  be  ap- 
plied first  to  the  amortization  of  the  premium  paid,  then 
the  balance  of  the  income  may  be  considered  as  revenue. 
If  the  bond  had  been  purchased  below  par,  its  approach- 
ing maturity  and  the  possibility  of  collecting  par  in- 
creases the  value  of  the  bond  and  the  account  should,  in 
the  absence  of  statutory  regulations,  be  increased  by  the 
amount  of  the  accumulation. 

In  ascertaining  the  amount  by  which  a  bond  account 
should  be  increased  or  decreased  on  the  books  each  year, 
reference  should  be  had  to  some  Bond  Table,  copies  of 
which  can  be  secured  at  any  book  store. 

In  many  cases,  the  bond  accounts  are  adjusted  each 
year  by  using  the  market  quotation  as  the  basis  of  val- 
uation. This  plan  is  incorrect  in  that,  at  the  time  a  bond 
is  purchased,  the  purchase  price  is  based  on  some  pre- 
determined ratio  of  yield  and  any  basis  of  valuation 
which  does  not  give  effect  to  this  ratio  of  yield,  subject 
to  contingencies,  must  improperly  state  the  income  on 
the  investment  unless,  of  course,  the  bond  does  not  rep- 
resent a  permanent  investment. 

Bonds  purchased  for  immediate  resale  could  properly 


INVESTMENTS  95 

be  valued  at  cost  less  an  allowance  for  an  unfavorable 
fluctuation,  the  same  as  other  items  dealt  in. 

Many  classes  of  bonds  are  issued  with  the  intention 
of  refunding  them  if  it  is  impossible  to  care  for  them  at 
maturity.  In  any  case,  it  is  very  seldom  that  the  higher 
grade  of  bonds  are  foreclosed,  therefore  it  seems  unnec- 
essary to  provide  for  loss  through  their  non-payment,  par- 
ticularly so,  if  the  bonds  have  a  long  time  to  run;  but 
bonds  of  the  speculative  class  are  of  uncertain  value  and 
the  investor  should  not  be  too  hasty  in  accepting  his  in- 
terest or  his  stock  bonus  as  profit.  The  possibility  of  a 
loss  resulting  through  an  unsatisfactory  refunding  agree- 
ment or  through  foreclosure  may  be  provided  for  by  re- 
serves if  desired. 

Investments  in  Securities,  In  General. 

Where  investments  are  made  in  securities  from  funds 
which  have  been  reserved  for  some  specific  purpose,  it 
seems  unnecessary  to  provide  for  a  minor  loss  that  might 
occur  at  the  time  of  their  sale,  for  in  no  case  would  the 
loss  affect  the  operation  of  the  business  and  it  would 
simply  mean  that  instead  of  having  a  particular  sum 
in  reserve  the  amount  might  be  slightly  reduced  at  the 
time  of  realization.  Of  course  if  the  loss  was  so  great 
that  the  balance  sheet  would  result  in  a  mis-statement  or 
that  the  result  to  be  obtained  by  the  reserve  was  defeated, 
it  should  be  given  effect  and  both  the  reserve  and  the 
investment  accounts  should  be  reduced  to  a  more  proper 
amount. 

Where  a  considerable  number  of  securities  are  held  by 
a  concern  dealing  in  securities,  it  is  possible  that  certain 
of  them  have  decreased  in  value  while  others  have  in- 
creased, in  which  case,  instead  of  entirely  ignoring  any 
increase  due  to  a  fluctuation  in  the  market  value,  it  is 


96  ACCOUNTING  PRINCIPLES 

considered  proper  to  allow  the  increases  to  offset  the  de- 
creases; but  where  a  loss  will  undoubtedly  occur,  an 
amount  is  credited  to  an  Investment  Fluctuation  Account 
and  charged  against  the  income  of  the  current  year  to  pro- 
vide for  the  loss  should  it  eventually  occur. 

Consideration  should  be  given  the  possibility  of  se- 
curing a  favorable  market  quotation  by  the  aid  of  "Ac- 
commodation Transactions"  between  members  of  a  group 
of  investors  and  of  using  this  favorable  quotation  as  a 
basis  of  an  overvaluation  on  some  particular  investment 
and  a  consequent  covering  of  losses. 

In  the  case  of  a  firm  holding  securities  other  than  as 
a  dealer  in  them,  no  charge  could  be  made  against  Income 
from  Operations  to  provide  for  the  loss,  for  this  would 
refer  to  the  investor's  business  as  a  trader  or  manufac- 
turer instead  of  as  an  investor.  Any  adjustments  would 
have  to  be  made  from  the  Net  Profits  Account  direct. 


INVESTMENTS  97 


C.  P.  A.  Questions 

1.  You  find  in  your  annual  audit  of  an  Investment 
Co.  that  bonds  of  another  company  are  included  amongst 
tlic  assets  at  their  face  value,  though  purchased  at  a  dis- 
count; that  such  discount  has  been  considered  as  com- 
mission earned  and  so  credited  to  Profit  and  Loss  Ac- 
count and  later  carried  to  a  Reserve  Fund.    What  is  your 
opinion  of  the  transaction?     If  it  does  not  meet  with 
your  approval,  how  would  you  have  recorded  the  trans- 
action?    (Adapted  from  D.  A.  A.) 

2.  Describe    the    various    methods    which    you    have 
met  with  for  writing  off  the  premium  on  bonds  purchased, 
pointing  out  their  weaknesses  or  advantages.     What  is 
the  most  scientific  method  of  dealing  with  premiums  paid 
and  upon  what  principle  is  it  based?     (111.) 

3.  A  corporation  owns  three  parcels  of  real  estate, 
one  unimproved  which  produces  no  income;  one  partly 
improved  which  produces  just  sufficient  to  provide  for 
the  taxes,  and  the  third  fully  improved  which  produces 
a  considerable  sum  in  addition  to  the  taxes  and  other 
expenses.    How  should  the  accounts  appear  on  the  books? 
(Wash.) 

4.  A  corporation  formed  to  invest  in  certain  classes 
of  securities  has  made  a  serious  loss  on  paper  by  the  fall 
in  the  price  of  some  of  its  purchases,  while  it  has  earned 
enough  on  income  to  pay  the  usual  dividend.    How  should 
this  be  dealt  with  in  the  annual  accounts?     (111.) 

5.  Finance  corporations  holding  a  large  number  of 
shares  in  other  corporations  are  in  the  habit  of  valuing 
their  securities  for  Balance  Sheet  purposes  at  either  (a) 


98  ACCOUNTING  PRINCIPLES 

cost  price,  or   (b)   market  price  at  the  date  of  the  Bal- 
ance Sheet. 

Discuss  the  respective  merits  of  the  two  methods  and 
say  which  you  consider  the  soundest  from  an  account 
ant's  point  of  view.  (111.) 

6.  An  insurance  company  buys  $50,000  1%  10  year 
bonds  at  116  for  investment.     The  bonds  will  mature  at 
the  expiration  of  5  years.     What  should  be  done  with 
the  premium?     (N.  Y.) 

7.  "A."   Company  invests  |135,000  in   stock   of  "B" 
Company,  receiving  1,000  shares.     The  books  of  the  "B" 
Company  at  that  time  disclosed  the  following:  Capital 
Stock,  $110.000;  Surplus,  $38,500.     During  the  year  im- 
mediately  succeeding  the   purchase,   the   "B"   Company 
earned  $19,250  and  at  the  end  of  the  year,  declared  a 
dividend  of  $57,750.    What  sum  can  "A"  Company  assume 
as  profit.     (XXX.) 


CHAPTER  XII 

Capital  Assets 

Capital  Assets  represent  the  acquisitions  of  a  concern 
which  are  intended  to  be  of  a  permanent  nature  and 
which  are  presumably  purchased  from  the  Capital  In- 
come. 

Their  permanence  in  the  business  requires  that  they 
receive  a  different  treatment  than  that  given  the  assets 
which  are  to  be  immediately  disposed  of  or  which  are 
held  ready  for  immediate  disposal.  The  principal  differ- 
ences being  that  due  allowance  must  be  made  for  the 
decrease  in  the  value  of  the  property  from  day  to  day 
owing  to  the  approach  of  the  time  after  which  it  will  be 
impracticable  or  impossible  to  use  it  and  also  to  the  ne- 
cessity of  counteracting,  to  a  certain  extent,  the  result 
of  the  use  of  the  asset. 

The  fact  that  they  are  often  purchased  with  the  Cap- 
ital Stock  of  the  concern,  which,  in  general,  is  of  an  in- 
determinable value  and  which  it  is  usually  desired  should 
appear  to  have  been  exchanged  for  articles  possessing  at 
least  its  face  value,  gives  rise  to  the  inflation  of  the  value 
of  the  assets  which  are  acquired  with  it. 

As  an  example,  take  the  case  of  a  concern  incorporated 
to  acquire  the  assets  of  some  particular  plant.  At  the 
time  of  incorporation  it  is  usually  desired  to  give  sta- 
bility to  the  firm  by  having  a  considerable  Capital  Stock 
and  by  Inning  it  appear  as  fully  paid.  In  order  to  ac- 
complish this  without  investing-  additional  funds  in  the 
corporation,  it  is  customary  to  take  over  the  assets  of  the 
firm  at  the  par  value  of  the  stock  given  in  exchange,  even 


100  ACCOUNTING  PRINCIPLES 

though  the  assets  do  not  possess  a  value  equal  to  the 
predetermined  value  of  the  stock,  then,  in  order  to  make 
the  value  of  the  assets  acquired  indeterminable,  it  is  con- 
sidered necessary  to  place  them  on  the  books  in  an  in- 
definite manner,  say  as  Plant  or  Equipment,  without  an 
appraisal  or  inventory. 

This  mode  of  procedure  should  be  discouraged  when- 
ever possible  for  it  not  only  misrepresents  the  actual 
worth  of  the  concern  but  it  also  makes  the  earnings  of 
the  concern  appear  to  be  considerably  less  than  they 
actually  are  as,  no  matter  at  what  value  the  asset  may 
have  been  acquired,  during  its  life,  this  value  must  be 
cared  for  by  charging  it,  in  installments,  against  the  earn- 
ings of  the  business;  and,  if  the  amount  at  \vhich  it  is 
placed  on  the  books  is  excessive,  the  annual  installments 
under  the  inflated  value  will  be  proportionately  larger 
than  they  should  be  and  the  earnings  will  appear  smaller 
than  they  actually  are.  It  is  undoubtedly  more  desirable 
to  show  the  Capital  Assets  at  their  appraised  value  and 
to  have  the  books  display  the  difference  between  this 
value  and  the  par  value  of  the  stock,  which  is  given  in 
exchange  for  the  asset,  as  a  discount  on  the  stock  or,  if 
conditions  warrant,  as  goodwill.  In  either  case,  if  de- 
sired, the  excess  could  be  written  off  out  of  Surplus  with- 
out disturbing  the  actual  earnings  as  displayed  by  the 
books. 

Conditions  do  arise  where  a  concern  may  purchase 
certain  articles  which  will  require  rebuilding  or  recon- 
struction before  being  available  for  service.  The  rule 
that  the  asset  must  be  in  actual  working  order  and  ready 
to  operate  before  capital  charges  cease  holds  true  in  this 
case,  as  in  others,  and  all  expenditures  made  in  prepar- 
ing the  asset  for  such  service  are  properly  chargeable  to 
the  account  representing  the  asset  and  therefore  repre- 


CAPITAL  ASSETS  •  'ifa. 

sent  a  Capital  Kxpenditure;  provided,  however,  that  at 
the  time  of  purchase  the  asset  was  known  to  be  in  such 
a  condition  that  additional  expenditure  would  be  neces- 
sary before  it  would  be  ready  for  service,  otherwise  the 
expenditure  or  at  least  a  portion  of  it  would  represent 
a  loss  on  the  purchase  and  would  be  a  charge  against 
"Xc-t  Profits." 

It  is  also  possible  that,  in  order  to  secure  a  certain 
business,  a  considerable  number  of  assets  might  be  pur- 
chased with  the  business  which,  although  a  portion  of 
the  Capital  Assets  of  the  vendors  may  not  be  desirable 
for  the  purposes  of  the  vendees  and  which  would  neces- 
sarily be  discarded  shortly  after  their  acquisition  to 
make  room  for  more  modern  equipment.  In  this  case,  at 
the  time  of  purchase,  the  undesirable  machinery  should 
have  been  placed  on  the  books  at  its  scrap  value  but,' if 
it  was  not  at  the  time  of  its  sale,  the  book  value  should 
be  adjusted  and  any  difference  closed  into  Goodwill.  Of 
course,  if  at  the  time  of  purchase  it  was  intended  to  use 
the  equipment  and  if  it  was  believed  to  be  desirable  for 
the  purposes  of  the  new  concern  and  if  its  purchase 
price  was  made  accordingly,  it  would  represent  a  loss  on 
the  purchase  and  would,  more  properly,  be  a  charge 
against  "XH  Profits/'  in  which  case,  if  the  loss  rep- 
resented a  considerable  sum  and  if  it  caused  an  impair- 
ment of  Capital,  it  would  be  undesirable  and  improper 
to  distribute  additional  Capital  as  dividends. 

(ioods  might  also  be  acquired  on  the  installment  plan, 
the  purchase  price  of  which  would,  possibly,  be  consider- 
ably in  excess  of  the  cash  price  that  would  have  been  se- 
cured had  the  money  been  available.  Such  purchases,  if 
they  amount  to  any  considerable  sum,  should  be  appor- 
tioned over  "Cost"  and  "Interest  on  Installment  Pur- 
chases." The  Interest  account  could  then  be  reduced  from 


102  ACCOUNTING  PRINCIPLES 

period  to  period  proportionate  to  the  life  of  the  contract 
and  the  amounts  outstanding  from  term  to  term. 

During  the  time  a  concern  is  being  prepared  to 
operate  there  are  many  expenditures  which  may  or 
may  not  be  properly  charged  to  the  Capital  and  many 
differences  of  opinion  exist  as  to  just  what  is  proper 
under  certain  conditions.  The  principal  points  of  differ- 
ence refer  to  the  expenditures  incurred  in  floating  the 
organization  and  will  be  dealt  with  next. 

Organization  Expenses. 

The  Organization  Expenses  of  a  corporation  may 
properly  include  all  legal  expense  incidental  to  its  or- 
ganization, the  incorporation  fee,  seal,  stationery,  pros- 
pectus, commissions  or  other  expense  incidental  to  the 
sale  of  stock  or  bonds,  rent,  salaries  and,  in  fact,  every 
expense  of  every  kind  which  may  properly  be  incurred  in 
organizing  the  concern.  This  sum  is  placed  on  the  books 
as  a  Capital  Asset  but,  in  general,  is  written  off  during 
the  first  few  years  of  the  life  of  the  organization.  In  the 
case  of  concerns  operating  but  a  limited  period,  it  may 
be  spread  over  the  life  of  the  organization  but  the  former 
method  is  usually  preferred. 

A  Discount  on  the  sale  of  stock  should  not  under  any 
condition  be  included  in  the  Organization  Expenses.  In 
fact,  it  is  doubtful  if  a  company  has  authority  to  dispose 
of  its  stock  except  at  par  or  at  a  premium;  but,  should 
such  a  procedure  seem  justifiable  owing  to  the  urgency  of 
conditions  and  should  occur,  the  discount  should  be  sep- 
arately stated  on  the  books  and  should  be  wiped  out  from 
future  profits  by  a  charge  against  Surplus,  or,  more  prop- 
erly, Dividends  Payable  Account;  the  object  of  so  doing 
being  to  complete  the  payment  on  the  stock  by  reverting 
funds  which  would  properly  fall  to  the  stockholders  un- 


CAPITAL  ASSETS  103 

der  normal  conditions,  toward  its  payment,  thereby  vir- 
tually paying  a  dividend  and  then  receiving  payment  for 
the  balance  due  on  the  stock. 

The  actual  amount  of  expenditure  incurred  during 
the  period  of  incipiency,  as  interest  on  a  Bond  issue, 
may  possibly  be  included  as  an  Organization  Expense 
but  it  is  believed  more  practical  to  include  such  a  charge 
in  the  Construction  Account. 

Bonds  Issued  for  Construction  Purposes. 

The  facts  that  bonds  are  issued  for  construction  pur- 
poses in  no  way  affects  the  final  disposition  of  any  dis- 
count or  premium  that  may  enter  into  consideration  at 
the  time  of  their  disposal.  As  explained  in  a  previous 
chapter,  any  difference  that  may  exist  between  the  par 
value  of  a  bond  and  its  market  value  may  be  traced  to  a 
difference  between  the  interest  the  bond  bears  and  the 
value  of  money  at  the  time  of  its  disposal.  This,  of 
course,  has  no  bearing  whatsoever  on  the  cost,  in  dollars, 
of  the  property  constructed  from  the  funds  secured  by 
the  sale  of  bonds. 

The  effective  rate  of  interest  paid  on  the  bond  is  a 
charge  for  the  use  of  the  money  and  if  it  accrues  during 
the  time  a  concern  is  in  operation  it  is  properly  a  charge 
against  Net  Profits;  but  that  portion  of  the  interest  that 
actually  accrues  during  the  time  a  concern  is  being  pre- 
pared for  operations,  is  a  charge  to  some  Capital  Asset, 
usually  Construction  or  Plant  Accounts. 

The  effective  interest  is  the  interest  charged  after 
cai  ing  for  the  annual  adjustment  of  the  "Discount  on 
Bonds"  or  the  "Premium  on  Bonds"  Accounts.  These 
accounts  having  been  placed  on  the  books,  at  the  time 
the  bonds  were  disposed  of,  to  contain  the  difference  be- 
tween the  sale  price  and  the  par  value  of  the  bonds,  with 
the  intention  of  adjusting  any  difference  that  might  ex- 


104  ACCOUNTING  PRINCIPLES 

1st  between  the  interest  actually  paid  and  the  amount  of 
expenditure  incurred  during  each  year  through  them. 

Proper  Charges  to  Capital  After  Organization. 

The  method  of  operating  the  accounts  of  an  under- 
taking materially  affects  the  manner  of  handling  future 
expenditures.  Certain  corporations  are  organized  un- 
der a  provision  that  a  considerable  portion  of  the  money 
invested  must  be  devoted  toward  the  acquisition  of  cer- 
tain predetermined  fixed  assets  and  that  these  assets  must 
be  maintained  from  year  to  year  during  the  life  of  the  or- 
ganization. Under  this  plan  of  operation  no  charges  are 
made  for  depreciation,  neither  are  additional  expendi- 
tures capitalized  even  though  they  are  a  betterment  to 
the  concern,  except,  of  course,  that  they  actually  enlarge 
the  scope  of  the  organization  or  complete  some  step  al- 
ready contemplated  in  the  original  plan  of  organization. 

Double  Account  System. 

This  plan  of  operating  the  accounts  is  usually  classed 
as  the  Double  Account  System,  principally  on  account  of 
the  form  given  the  Balance  Sheet  owing  to  the  desire  to 
distinguish  between  the  expenditure  on  Capital  Assets 
and  the  Working  Capital.  In  the  Balance  Sheet,  the 
Capital  Assets  are  shown  in  comparison  with  the  Cap- 
ital Liabilities;  the  balance,  representing  the  excess  of 
the  Capital  Liabilities  over  the  Capital  Assets,  being  car- 
ried forward  into  a  second  section  as  Working  Capital. 

There  are  many  objections  to  the  working  of  the  sys- 
tem and  as  it  is  but  little  used  we  are  devoting  as  little 
space  to  it  as  possible. 

Single  Account  System. 

The  Single  Account  System — that  in  general  use- 
properly  distinguishes  between  Capital  and  Revenue  Ex- 


CAPITAL  ASSETS  '  105 

penditures  and  takes  into  consideration  the  value  of  the 
nse  of  the  property. 

ruder  this  system,  and  as  outlined  in  the  chapter  on 
Capital  and  Revenue,  all  expenditures  which  actually  in- 
crease or  extend  its  operations  or  make  its  operation 
more  permanent  should  be  charged  to  the  Capital  Assets 
under  some  appropriate  heading;  all  others  should  be 
charged  to  Revenue.  As  simple  as  this  rule  may  seem, 
there  are  many  puzzling  circumstances  which  cause 
trouble  in  determining  just  what  is  and  what  is  not  a 
proper  charge  to  either  of  these  classes  of  accounts. 

Articles  Prepared  for  Use  of  Firm. 

In  general,  we  believe  that  a  firm  is  not  justified  in 
carrying  any  fixed  asset  on  its  book  in  excess  of  its  actual 
cost — surely  no  firm  would  be  justified  in  accepting  as 
profits  and  in  declaring  as  a  dividend  any  profit  pre- 
sumed to  have  resulted  by  making  a  portion  of  their  plant 
or  equipment  in  their  own  shop.  In  estimating  the  cost 
of  such  an  article  it  would  be  proper  to  include  every- 
thing connected  with  its  construction  and  preparation 
for  operation,  including  the  oncost  or  overhead  charges, 
which  item  would  properly  include  a  portion  of  the  super- 
intendence and  management  of  the  factory  as  well  as  rent, 
heat,  light,  etc.,  but,  should  an  occasion  arise,  wherein 
owing  to  mismanagement  or  miscalculations,  the  article 
prepared  by  the  firm  for  its  own  use  should  cost  more 
than  the  actual  cost  of  such  an  article  if  purchased 
through  outsiders,  it  would  not  be  proper  to  place  the 
entire  cost  on  the  books  as  a  charge  to  capital ;  preferably, 
the  loss  or  excessive  cost  should  be  charged  against  Net 
Profits  during  the  current  period  and  the  market  price 
placed  on  the  books  as  the  value  of  the  article. 


106  ACCOUNTING  PRINCIPLES 

Moving  and  Altering. 

Moving  or  altering  a  plant,  in  general,  does  not  ma- 
terially increase  the  capital  value  or  the  stability  of  the 
organization  and  unless  there  is  a  distinct  betterment,  it 
is  believed  desirable  to  charge  the  entire  amount  to  rev- 
enue during  the  period  in  which  it  occurs;  of  course,  if 
the  charges  for  alteration  or  moving  amount  to  a  con- 
siderable sum  and  if  such  action  will  reduce  the  opera- 
tion expenses  to  any  great  degree  in  future  years,  it  would 
not  be  proper  to  allow  the  current  year  to  suffer  the  en- 
tire amount  to  the  benefit  of  future  years;  therefore,  the 
expense  incidental  to  moving  or  altering  may  be  prop- 
erly spread  over  a  number  of  years  if  such  a  course  is 
desired. 

Replacements. 

We  believe  that  the  generally  accepted  use  of  the  term 
replacement,  in  accounting,  is  in  reference  to  the  remov 
ing  of  one  article  and  the  substitution  of  another  of  the 
same  or  greater  value  as  distinguished  from  a  renewal 
which  simply  makes  good  some  already  existing  article 
by  a  process  of  re-manufacture  or  extensive  repairs. 

A  replacement,  then,  should  result  in  a  credit  to  Plant 
or  Machinery  Account  for  the  value  of  the  article  dis- 
placed and  a  charge  for  the  article  substituted.  If  this 
plan  is  followed  closely  and  care  is  taken  in  ascertaining 
the  actual  book  value  of  the  article  replaced,  very  little 
difficulty  should  occur  in  handling  such  items. 

In  ascertaining  the  value  of  the  article  displaced,  the 
process  is  considerably  simplified  if  it  is  possible  to  refer 
to  a  Plant  or  Equipment  Ledger  to  find  the  cost  of  the 
article  and  also  its  reduced  value;  but,  if  such  a  ledger 
is  not  maintained,  the  book  value  of  the  individual  article 


CAPITAL  ASSETS  107 

can  be  easily  determined  if  the  date  of  purchase  and  the 
rate  allowed  for  depreciation  is  known. 

Occasions  often  arise  wherein  extensive  replacements 
become  necessary  but  where  proper  provision  has  not  been 
made  for  the  obsolescence  of  the  article  displaced,  in 
which  case  a  considerable  loss  will  result  at  the  time 
the  obsolete  article  is  removed,  owing  to  the  failure  to 
realize  the  book  value  of  the  article  scrapped.  This  loss 
should  have  been  provided  for  during  previous  years,  but 
if  it  was  not,  it  should  become  a  charge  against  Surplus. 
If  there  is  not  a  sufficient  Surplus  after  crediting  the 
current  year's  profits  to  cover  the  loss  and  also  a  divi- 
dend, no  dividend  should  be  declared.  In  general,  how- 
ever, if  a  concern  is  in  a  healthy  state  and  if  under  old 
conditions  while  operating  the  obsolete  equipment  it  was 
able  to  make  a  fair  profit  and  if  future  conditions,  under 
the  operation  of  new  and  improved  equipment,  are  such 
that  a  considerably  larger  profit  may  properly  be  antic- 
ipated, it  is  customary  to  spread  the  loss  over  a  consid- 
erable number  of  years  and  to  declare  a  small  dividend 
from  year  to  year  even  though  the  loss  has  not  been  en- 
tirely cared  for. 

In  case  an  organization  entirely  replaces  some  of  its 
fixed  assets  at  a  considerable  expense,  the  expenditure 
may  or  may  not  result  in  a  direct  increase  of  the  earn- 
ings of  the  organization  owing  to  the  purpose  of  the 
asset,  as  in  the  case  of  a  steamship  company  replacing  a 
dock  with  a  larger,  more  modern  and  much  improved 
structure,  and  considerable  doubt  exists  as  to  whether  the 
expenditure  could  properly  be  capitalized.  In  general, 
where  an  expenditure  of  this  kind  is  made  it  is  done  with 
the  intention  of  improving  the  service  to  the  public,  main- 
taining their  goodwill  and  securing  a  continuation  of 
their  business,  therefore,  as  the  stability  of  the  organ i- 


108  ACCOUNTING  PRINCIPLES 

zation  is  increased  and  as  there  is  undoubtedly  a  better- 
ment of  fixed  assets,  the  expenditure  should  be  capital- 
ized and  the  old  asset  displaced  on  the  books. 

Conversions. 

In  the  operation  of  many  classes  of  undertakings, 
certain  portions  of  the  equipment  become  unsuited  for 
the  purpose  for  which  they  are  being  used  and  it  becomes 
necessary  to  replace  them  by  larger,  more  modern  or  bet- 
ter articles,  although,  owing  to  the  scope  of  the  under- 
taking, the  displaced  articles  may  be  converted  into  use 
in  some  other  place.  This  brings  up  the  question  of  the 
value  at  which  the  part  converted  into  use  in  the  new 
place  should  be  placed  on  the  books,  i.  e.  should  the  book 
value  remain  on  the  books,  or  should  the  asset  be  con- 
considered  at  its  market  value  and  the  new  department 
or  district  as  the  purchaser  at  that  price. 

The  latter  valuation  is  often  adopted  by  account- 
ants but  it  seems  rather  hard  to  determine  with  any 
degree  of  accuracy  as  the  market  value  of  used  material 
is  generally  a  question  of  barter  rather  than  of  a  quo- 
tation and,  as  no  attempt  is  to  be  made  to  dispose  of  the 
article,  the  opportunity  of  barter  is  lost  and  the  estimate 
of  value  must  be  simply  a  conjecture;  therefore,  so  long 
as  the  book  value  is  not  exorbitant  and  the  value  of  the 
asset  has  been  depreciated  from  year  to  year  during  its 
life,  it  is  believed  proper  to  allow  the  book  value  to  remain 
on  the  books  irrespective  of  the  location  of  the  asset, 
provided  it  still  remains  in  use. 

In  either  of  the  cases  mentioned  above,  all  cost  of  re 
moving  the  old  asset  should  be  charged  to  revenue.  In 
case  the  book  value  remains  on  the  books,  the  cost  of  in- 
stalling should  also  be-  charged  to  revenue;  but  if  the 
market  value  rules  the  cost  of  installing  could  properly 
be  capitalized. 


CAPITAL  ASSETS  109 

Appreciation  from  Outside  Sources. 

The  effect  of  outside  conditions  on  the  Capital  Assets 
should  be  ignored,  viz.,  even  though  the  property  of  an 
organization  may  have  greatly  increased  in  value,  no 
effect  should  be  given  this  increase  until  the  property 
has  actually  been  disposed  of,  for,  no  matter  how  much 
greater  the  value  may  be,  no  profit  could  be  accepted  as 
available  for  dividends  until  it  had  actually  been  real- 
ized. 

In  cases  where  it  is  particularly  desired  that  the  as 
set  be  written  up  on  the  books,  to  its  estimated  value,  and 
this  is  done,  care  should  be  taken  to  credit  the  amount 
representing  the  increase  to  some  special  reserve  account, 
properly  headed,  so  that  under  no  condition  could  it  pos- 
sibly be  considered  as  closeable  into  Surplus  and  event- 
ually into  Dividends  Payable,  thereby  resulting  in  a  fic- 
titious dividend. 


110  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  A  corporation,  having  acquired  a  manufacturing 
plant,  discards  shortly  after  its  acquisition  a  large  por- 
tion of  the  machinery  and  replaces  it  by  machinery  of  a 
more  modern  type,      (a)    What  do  you  consider  is  the 
correct  method  of  dealing  on  the  books  with  the  book 
value  of  the  discarded  machinery?     (b)  Do  you  consider 
that  it  would  be  proper  for  the  corporation  to  pay  divi- 
dends until  the  value  of  the  discarded  machinery  had 
been  written  off  out  of  profits?     Give  full  reasons  for 
your  answer.     (Wash.) 

2.  What  is  the  proper  manner  of  placing  assets  on 
the  books  where  payment  has  been  made  in  stock,  the 
face  value  of  which  is  greatly  in  excess  of  the  actual 
value  of  the  asset?     (XXX.) 

3.  If   a   company,   duly   organized,   acquires   several 
plants  that  are  found  to  be  in  a  "run  down"  condition 
and  to  require  extensive  outlay  for  repairs  and  renewals 
to   bring   them   up   to   the   required    state   of   efficiency, 
should  such  outlay  be  charged  against  Capital  or  against 
Revenue?    Give  reasons.     (N.  Y.) 

4.  A  corporation  issues  bonds,  proceeds  to  be  used 
for  construction  purposes.     If  bonds  are  sold  at  a  dis- 
count, to  what  account  should  the  discount  be  charged? 
If  sold  at  a  premium,  to  what  account  should  the  pre- 
mium be  credited?     (111.) 

5.  In  the  construction  of  a  large  building  the  pro- 
prietors issue  $800,000.00  20-year  6%   bonds  which  are 
disposed  of  to  the  contractors  at  85%  of  their  face  value. 
You  find,  upon  examination,  that  the  discount  of  15% 
has  been   charged  to  Construction  Account  in   the  first 
place,  and  then  to  Building  Account. 


CAPITAL  ASSETS  111 

State  whether  you  consider  the  final  entry  legitimate 
or  not,  and  give  reasons.  (111.) 

G.  After  the  organization  of  a  corporation,  it  pro- 
ceeds to  construct  a  manufacturing  plant,  paying  for  the 
same  in  cash  realized  from  the  sale  of  capital  stock  at 
80  cents  on  the  dollar.  When  ready  for  operation,  what 
items  would  be  included  in  the  cost  of  such  a  plant? 

(in.) 

7.  Do  you  consider  that  interest  paid  on  Capital  dur- 
ing the  construction  of  a  dock  should  be  charged  to  Cap- 
ital?    (XXX.) 

8.  What  is  usually  included  in  the  account  "organ- 
ization  expenses"   in   the   books   of   a   company?     How 
should  this  account  be  treated?    Give  reasons.    (N.  Y.) 

9.  Can  or  cannot,  a  going  concern,  employing  a  sal- 
aried manager  and  superintendent,  charge  any  part  of 
their  salaries  to  cost  of  improvements  or  extensions  that 
may  be  added  to  the  plant  at  intervals?    In  either  view, 
why?     (111.) 

10.  A  concern  engaged  in  building  locomotives  wishes 
to  equip  their  machine  shop  with  some  new  machinery  of 
standard  types,  and  determines  to  have  it  made  in  their 
own  plant  by  their  own  workmen  from  material  which 
they  have  in  stock.    By  this  means  it  will  cost  much  less 
than  if  they  bought  it  from  outsiders.     They  desire  con- 
sequently to  charge  their  "Machinery  and  Large  Tools" 
account  with  the  current  market  price  of  the  machinery 
so  produced,  on  the  ground  that  their  workmen,  while 
making  it,  have  been  detached  from  other  profitable  em- 
ployment. 

Discuss  this  question -pro  and  con,  and  say  what  you 
would  advise  to  be  done,  giving  reasons.  (Penn.) 

11.  The  North  &  South  R.  R.  Co.  has  demolished  its 
old  wooden  station  at  a  certain  city  on  its  line  and  has 


112  ACCOUNTING  PRINCIPLES 

erected  in  its  place  a  larger  and  more  ornate  structure  of 
brick  and  stone,  at  a  cost  of  $100,000.00  in  excess  of  the 
book  value  of  the  old  building  after  deducting  the  salvage. 
Bearing  in  mind  that  this  expenditure  of  $100,000.00  does 
not  materially  increase  the  earning  capacity  nor  decrease 
the  operation  expenses  of  the  company,  what  disposition 
should  be  made  of  this  item  in  the  accounts? 

State  the  general  principles  that  should  govern  an 
accountant  in  dealing  with  this  class  of  expenditure, 
whether  occurring  in  a  railroad  or  any  other  property. 
(N.  Y.) 

12.  A  manufacturing  concern,  having  increased  its 
capital  and  invested  considerable  money  in  new  machin- 
ery and  in  the  construction  of  old  machinery,  removes 
to  a  new  location  and  charges  the  cost  of  moving  and 
the  reconstruction  of  its  old  machinery  to  one  account 
termed  "installation."     Explain  fully  how  this  account 
should  be  treated  in  closing  the  books  of  the  company 
and  give  reasons.     (N.  Y.) 

13.  A  factory  makes  large  outlay  during  a  year  for 
alteration  to  plant,  how  would  you  treat  such  expendi- 
tures?    (N.  Y.) 

14.  The   Real   Estate   holdings   of  a   manufacturing 
Corporation,   of  which  you   are   auditor,   have   substan- 
tially increased  in  value  since  their  purchase.     The  di- 
rectors have  caused  the  Real  Estate  Account  on  the  books 
to  be  debited  and  Profit  and  Loss  Account  credited  with 
the  amount  of  the  increased  value. 

Do  you  consider  this  procedure  justified?  State  rea- 
sons for  your  answer.  (Wash.-) 

15.  Expenditures  are  made  by  a  corporation  for  items 
of  each  of  the  following  classes:      (a)    taking  down   a 
machine  in  one  part  of  the  factory,  moving  it  and  putting 
it  up  in  another  part,  (b)  expenses  of  incorporating  the 


CAPITAL  ASSETS  113 

company,  including  state  charges  and  lawyer's  services, 
(c)  brokerage  on  purchase  of  a  piece  of  property,  (d) 
commission  on  an  issue  of  debenture  bonds,  (e)  cost  at- 
tending a  mortgage,  (f)  furniture  and  fittings  of  a  city 
office  and  salesroom,  (g)  costs  of  patents,  including  so- 
licitor's charges  and  government  fees.  Which  items 
should  be  charged  to  capital  and  which  to  revenue?  State 
reasons  for  your  answer  in  each  case.  (N.  Y.) 

K>.  After  appraisement,  a  manufacturing  corpora- 
tion increased  the  book  value  of  its  real  estate  to  the  ap- 
praised figure,  carrying  the  amount  of  the  appreciation 
to  Tudivided  Profits  Account.  Shortly  afterwards,  the 
corporation  declares  a  dividend  to  pay  which,  a  part  of 
the  Real  Estate  Appreciation  is  required.  Do  you  con- 
sider that  the  corporation  is  justified  in  treating  appre- 
ciation of  real  .estate  as  an  earned  profit  (assuming  the 
real  estate  to  be  used  for  the  purpose  of  the  business) 
and  in  paying  that  appreciation  out  as  dividends.  State 
fully  reasons  for  your  answer.  (Wash.) 

17.  A  suburban  traction  company  after  equipping 
its  lines  at  a  very  considerable  expense  for  overhead  trol- 
ley and  operating  same  for  several  years  decides  to  adopt 
the  third  rail  system.  Extensive  changes  are  necessary 
in  changing  power  houses,  re-arranging  tracks,  and  al- 
tering cars,  involving  an  expenditure  of  $25,000.  In  ad- 
dition  considerable  machinery  and  rolling  stock,  the  orig- 
inal value  of  which  had  been  treated  as  a  capital  outlay 
and  was  carried  on  the  books  at  a  valuation  of  $25,000 
is  rendered  obsolete  and  is  disposed  of  for  $3,500,  show- 
ing a  loss  of  $21,500.  The  profits  from  operation  for  the 
year  are  $18,000. 

State  how  you  would  recommend  that  the  matter  be 
dealt  with  in  the  company's  accounts  and  whether  the 
company  can  pay  a  dividend?  (111.) 


CHAPTER  XIII. 

Depreciation 

Depreciation  in  its  broadest  sense  is  an  impairment 
of  value.  As  applied  to  accounting,  it  represents  the  im- 
pairment due  to  wear  and  tear,  obsolescence  or  effluxion 
of  time. 

Depreciation  Charge. 

Any  allowance  that  may  be  made  for  depreciation 
should  give  consideration  to  these  items  and  should  be 
made  with  a  view  of  caring  for  the  entire  impairment 
during  the  period  of  active  life  of  the  asset. 

The  easiest  mode  of  application  seems  to  be  to  make  a 
simple  rental  charge  against  operation  to  cover  the  use 
of  the  asset. 

One  portion  of  the  business,  taken  as  a  whole,  should 
not  profit  at  the  expense  of  some  other  portion,  therefore, 
this  rental  charge  should  be  made  as  nearly  actual  cost 
as  it  is  possible  to  estimate,  or  looking  at  it  from  an- 
other standpoint,  a  sufficient  rental  should  be  charged 
against  operation  to  cover  the  cost  of  replacing  the  asset 
at  the  time  it  becomes  necessary  to  discard  it. 

The  plant,  etc.,  is  consumed  in  the  production  of  the 
article  manufactured,  therefore,  any  charges  that  are 
found  necessary  in  maintaining  or  renewing  it  should  be 
shown  as  a  specfic  item  of  cost.  The  fact  that  deprecia- 
tion goes  on  irrespective  of  operation  is  not  of  itself  a 
sufficient  argument  to  warrant  its  elimination  from  the 
accounts  representing  the  cost  of  the  articles  produced ; 
but,  if  during  any  particular  period  there  is  a  term  of 
idleness,  the  depreciation  that  occurred  or  that  is  esti- 


DEPRECIATION  115 

mated  to  have  occurred  could  easily  be  separated  from 
the  portion  directly  traceable  to  operation  and  could  be 
treated  accordingly.  During  periods  of  slightly  decreased 
output  we  believe  the  regular  depreciation  charges  should 
be  made. 

Buildings  may  or  may  not  be  used  exclusively  in  pro- 
duction, and  in  cases  where  the  depreciation  of  the  build- 
ing represents  a  portion  chargeable  to  cost  and  also  to 
selling  or  administrative  expense,  it  is  desirable  to  charge 
each  department  with  its  portion,  but  to  consider  it  as 
a  rental  charge  and  then  to  offset  the  rental  that  has  ac- 
crued during  the  year  by  a  charge  for  depreciation. 

Necessity  of  Providing  for  Depreciation. 

It  has  often  been  contended  that,  if  the  profits  of  any 
particular  year  did  riot  justify,  no  provision  for  depre- 
ciation could  be  made.  This  theory  is  surely  a  fallacy, 
for  no  matter  what  loss  might  result  during  a  year  ex- 
clusive of  depreciation,  the  impairment  of  the  asset  oc- 
curs and  should  be  cared  for. 

Depreciation  is  in  no  sense  like  a  dividend,  which 
can  be  increased  or  decreased  proportionate  to  the  profits 
available.  One  is  an  element  of  cost  and  the  other  sim- 
ply a  distribution  of  the  profits,  and  although  the  pro- 
vision for  depreciation  directly  affects  dividends,  the  dec- 
laration of  a  dividend  in  no  way  affects  depreciation. 

Kvery  pin-chase  of  material  or  plant  is  made  with  the 
intention  of  consuming  it  in  the  process  of  manufacture. 
In  the  case  of  the  material,  except  possibly  in,  the  case 
of  mines  or  (piarries,  the  residue  is  apparent  and  the 
amount  used  may  be  easily  recorded,  but  in  the  case 
of  the  plant,  it  is  almost  impossible  to  properly  record 
the  amount  consumed.  At  some  future  date  the  plant 
will  be  discarded  probably  because  it  is  worn  out  or  more 


116  ACCOUNTING  PRINCIPLES 

likely  to  allow  the  installation  of  some  more  improved 
article;  in  any  case  the  day  of  its  final  discard  is 
approaching  and  provision  must  be  made  from  period 
to  period  for  its  impairment. 

In  the  case  of  very  large  undertakings,  it  has  been 
contended  that  there  is  practically  no  depreciation  for 
owing  to  the  scope  and  the  intended  continuity  of  the 
organization  and  the  necessity  of  thorough  and  con- 
tinuous overhauling  to  keep  the  asset  in  a  high  state  of 
efficiency  for  continued  operation,  the  expenditure  for 
repairs  and  renewals  would  be  sufficient  to  maintain 
the  asset  and  at  the  end  of  any  period,  the  asset  would 
be  worth,  so  far  as  the  operation  of  the  business  was 
concerned,  an  amount  equal  to  its  purchase  price  and 
book  value. 

This  argument  may  be  theoretically  correct  but  in 
actual  practice,  owing  to  the  inconsistence  of  human  na 
ture,  it  does  not  work  out  satisfactorily.  Where  depre- 
ciation is  not  accounted  for  and  where  the  repairs  and 
renewals  are  supposed  to  maintain  the  asset,  the  ten- 
dency of  managers  is  to  gauge  the  expenditure  for  such 
work  according  to  the  profits  of  the  period.  During  un- 
profitable years  repairs  and  renewals  are  dispensed  with, 
with  the  result  that  not  only  are  future  years  compelled 
to  stand  the  expense  of  the  prior  years  but,  as  the  failure 
to  make  repairs  usually  results  in  greatly  increased  de- 
preciation, they  must  stand  this  additional  loss  also,  and 
profits  are  incorrectly  stated  from  year  to  year. 

There  is  also  a  tendency  amongst  new  managers,  par- 
ticularly where  they  have  taken  over  the  management  of 
a  plant  which  is  in  a  run  down  condition,  to  increase 
the  Capital  Account  with  the  amount  expended  on  repairs 
and  renewals  for,  as  they  claim,  these  repairs  should 
have  been  made  during  the  previous  regime  and  should 


DEPRECIATION  117 

not  be  charged  against  the  current  year's  operation.  This 
also  results  in  an  improper  profit  and  should  not  occur 
in  any  well  regulated  organization. 

Many  cases  arise  where  profits  are  purposely  inflated 
by  persistently  giving  Revenue  the  benefit  of  all  doubtful 
expenditures  and  increasing  Capital  with  the  amount 
thereof,  with  a  corresponding  increase  in  the  profits  for 
the  period;  such  an  inflation  of  profits  invariably  results 
in  a  fictitious  dividend  and  a  consequent  impairment  of 
Capital,  therefore,  if  the  practice  of  capitalizing  items 
which  are  properly  a  charge  to  Revenue  were  to  continue 
for  any  considerable  period,  the  organization  would  be 
sadly  handicapped,  owing  to  a  lack  of  capital,  and  would 
eventually  have  to  cease  doing  business. 

The  argument  that  the  appreciation  of  the  Fixed  As- 
sets more  than  covers  the  depreciation  of  the  Plant  and 
therefore  makes  it  unnecessary  to  provide  for  the  depre- 
ciation, is  often  heard,  but  this  also  is  not  based  on 
sound  logic.  The  simple  fact  that  a  portion  of  the  prop- 
erty is  worth  more,  is  not  sufficient  excuse  for  assuming 
that  a  profit  has  been  made  upon  it.  In  fact  no  profit 
can  be  considered  until  the  sale  actually  occurs  and  it  is 
realized.  Therefore  this  increase  in  value  should  not  be 
allowed  to  offset  the  proper  charge  to  Revenue,  the  elim- 
ination of  which  would  result  in  an  increased  apparent 
profit.  Furthermore,  the  increase  may,  we  believe,  be 
properly  assumed  to  affect  land  only,  which  if  used  for 
ordinary  commercial  purposes  is  not  presumed  to  depre- 
ciate and  for  which  a  depreciation  charge  is  seldom  made. 
Its  increase  on  the  books  would  not,  in  any  case,  affect 
the  earnings  of  a  business,  and,  if  given  effect  at  all,  it 
would  appear  as  a  credit  to  an  account  headed  "Appre- 
ciation of  Real  Estate — Not  available  for  dividends"  and 
not  to  the  credit  of  Revenue,  therefore,  its  appreciation 


118  ACCOUNTING  PRINCIPLES 

should  not  be  used  as  an  offset  to  the  depreciation  on  some 
other  asset  which  the  business  is  supposed  to  maintain 
out  of  Revenue. 

If  the  Plant  or  Equipment  itself  could,  under  any 
possible  condition,  be  presumed  to  have  increased  in  value 
and  provided  that  it  was  considered  proper  to  give  this 
increase  effect,  would  not  the  annual  charge  for  depre- 
ciation, which  is  nominally  a  charge  for  the  use  of  the 
asset,  be  properly  increased  rather  than  diminished? 

One  writer  states  that  depreciation  should  not  be  con- 
sidered as  a  charge  against  operation  for  it  goes  on  ir- 
respective of  operation.  The  latter  fact  is  undoubtedly 
true,  in  fact  it  is  possible  that  an  article  may  suffer 
more  during  enforced  idleness  than  it  would  if  properly 
cared  for  during  a  much  longer  term  of  operation,  but, 
even  so,  the  asset  was  purchased  with  a  view  of  consuming 
it  in  the  production  of  the  articles  to  be  manufactured 
or  in  the  course  of  operation  and  its  cost  should  be  in- 
cluded in  the  cost  of  articles  produced  during  the  period 
of  use. 

If  during  any  particular  period  no  articles  are  pro- 
duced or  it  is  not  operated,  then  the  depreciation  must 
be  taken  from  previously  earned  profits,  or  if  no  Surplus 
or  Undivided  Profit  is  available,  it  results  in  an  impair- 
ment of  Capital  and  should  be  shown  as  such  on  the 
books  of  the  undertaking. 

From  a  legal  standpoint  there  is  a  growing  demand 
that  depreciation  be  cared  for  in  the  accounts  of  all  un- 
dertakings, particularly  corporations.  The  Interstate 
Commerce  Commission  demands  it  of  transportation 
companies.  The  majority  of  state  laws  affecting  the  op- 
eration and  accounting  of  public  service  corporations 
provide  for  it.  The  Internal  Revenue  Department  allows 
it  as  a  deduction  from  Gross  Income,  and  the  directors 


DEPRECIATION  119 

of  all  corporations  are  invariably  held  responsible  for 
fictitious  dividends,  therefore,  we  believe,  we  may  state 
that  an  allowance  for  depreciation  is  not  only  necessary 
from  an  accounting  standpoint  but  from  a  legal  stand- 
point as  well. 

Methods  of  Computing. 

The  annual  charges  to  Revenue  may  comprise: 

(a)  The  amount  expended  for  repairs  and  renewals 
and  also  an  equal  portion  of  the  cost  of  the  asset  based 
on  its  active  life  and  giving  consideration  to  its  residual 
value,  if  any. 

(b)  The  amount  expended  for  repairs  and  renewals 
and  also  a  certain  per  cent,  of  the  book  value  of  the  as- 
set.   The  book  value  to  be  reduced  each  year  by  the  charge 
for  depreciation,   thereby   resulting  in   a   corresponding 
reduction  in  the  charge  to  Revenue. 

(c)  A  proportionate  amount  of  the  estimated  expen 
diture  on  the  asset  during  its  life,  including  its  cost  and 
the  repairs  and  renewals. 

(d)  The  difference  between  the  appraised  value  of 
the  asset  at  the  beginning  and  the  end  of  each  period 
and  also,  if  they  were  not  charged  to  the  asset  direct,  the 
expenditures  for  repairs  and  renewals. 

Interest. 

Either  of  these  may  be  varied  slightly  by  including 
interest  on  the  book  value  of  the  asset  in  the  charge  to 
Revenue,  but,  except  in  the  case  of  a  leasehold,  it  appears 
that,  so  long  as  the  asset  represents  necessary  equipment 
of  the  undertaking  which  could  not  be  purchased  from 
year  to  year  and  which  does  not  represent  a  purchase  in 
advance  of  actual  requirements,  the  earnings  of  the  under- 
taking must  represent  the  return  for  the  Capital  invested* 
and  such  a  charge  is  unnecessary. 


120  ACCOUNTING  PRINCIPLES 

Annuity  System. 

Mention  is  often  made  of  the  Annuity  System  of  De- 
preciation. This  is  a  co-ordination  of  plain  UC"  but 
varies  from  it  by  the  inclusion  of  interest,  based  on  the 
assumption  that  depreciation  should  include  this  as  well 
as  Repairs  and  Renewals. 

This  plan  results  in  a  like  charge  to  revenue  each 
year,  but  as  the  interest  is  based  on  the  decreased  book 
value  from  year  to  year,  it  continually  decreases  and 
results  in  a  decreased  credit  to  Net  Profits. 

Replacement  Fund. 

A  fund  might  also  be  provided  by  investing  an  amount, 
equal  to  the  charge  for  depreciation,  in  securities  or  by 
depositing  this  sum  in  some  depository  from  which  re- 
placements might  be  made  without  interfering  with  or 
crippling  the  business.  The  plan,  however,  is  very  sel- 
dom adopted  as  it  results  in  removing  what  is  usually 
much  needed  capital  from  the  business  and  placing  it  in 
some  quickly  realizable  form  where  it  can  earn  but  a 
very  small  sum  in  comparison  with  its  value  to  the  bus- 
iness, and  as  in  very  few  cases  can  a  property  be  supposed 
to  require  replacement  all  at  once  or  with  such  rapidity 
that,  in  the  ordinary  course  of  business,  its  purchase 
could  not  be  accomplished  without  serious  difficulty. 
Where  the  plant  is  expensive  and  short  lived,  the  plan 
often  proves  very  satisfactory. 

Effect  of  Each. 

Each  of  the  methods  outlined  possesses  advantages 
under  particular  conditions;  for  instance,  the  plan  "a", 
of  spreading  the  cost  of  the  asset  in  equal  portions  over 
its  life,  is  desirable  where  the  active  life  of  the  asset  is 
known  and  where  its  residual  value  can  be  determined 


DEPRECIATION  121 

with  a  degree  of  accuracy  and  where  it  is  desired  that 
each  year  stand  an  equal  portion  of  the  cost  of  the  asset. 

The  plan  "b",  of  making  a  charge  of  a  certain  per 
cent,  of  the  reducing  balance  of  the  book  value  of  the 
asset:  results  in  decreasing  the  charge  to  revenue  for  de- 
preciation during  the  later  years  of  the  life  of  the  asset 
when  the  repairs  and  renewals  may  be  supposed  to  in- 
crease, and  also  in  retaining  some  sum  to  represent  the 
residual  value  no  matter  how  long  the  asset  may  remain 
in  use.  This  makes  the  plan  very  desirable  in  the  case 
of  machinery  and  similar  items  which  possess  a  residual 
value  and  which  it  is  desired  should  always  appear  in 
the  books. 

In  the  case  of  machinery,  in  particular,  it  may  be 
safely  assumed  that  the  annual  charge  for  repairs, 
renewals  and  depreciation  will  vary  from  year  to  year 
and,  in  theory,  plan  "c"  possesses  a  distinct  advantage  as 
the  annual  charge  to  Revenue  always  remains  the  same. 
This  plan,  however,  is  based  more  on  estimates  than 
either  of  the  others  and  loses  much  of  its  merit  on  that 
score  but,  provided  that  all  repairs  due  to  accident  are 
charged  to  Expenses  and  eventually  to  Revenue,  it  may 
still  be  equally  as  accurate  as  either  of  the  others.  It 
possesses  an  advantage  in  that  all  charges  in  the  way  of 
renewals  increase  the  book  value  of  the  asset  and  allow, 
as  they  undoubtedly  should,  for  an  increased  life  of  the 
asset.  This  plan  like  "a"  has  the  disadvantage  of  en- 
tirely wiping  the  asset  account  from  the  books  and 
should  be  avoided  wherever  the  asset  has  a  residual  value. 

In  theory  plan  "d"  is  the  best,  but  in  actual  practice 
it  is  found  to  be  the  most  inaccurate  of  all,  resulting  in 
great  variation  in  the  annual  charges  to  Revenue.  As 
a  proof  of  either  of  the  other  methods,  an  appraisal 
is  desirable,  but  no  effect  should  be  given  it  on  the 


122  ACCOUNTING  PRINCIPLES 

books  unless  there  is  a  considerable  discrepancy  be- 
tween the  appraised  value  and  the  book  value,  and  unless 
the  difference  arises  through  errors  in  the  depreciation  al- 
lowances rather  than  through  changes  in  the  market  value 
of  the  article  appraised  or  the  parts  thereof. 

If  it  is  considered  necessary  to  give  effect  to  the  ap- 
praised value,  the  book  value  should  first  be  reduced  by 
the  regular  charge  for  depreciation  for  the  period  under 
review,  then  the  Asset  account  should  be  adjusted  through 
the  Surplus  or  Undivided  Profits  accounts  and  the  rate 
of  depreciation  should  be  changed  to  a  more  accurate  one 
for  future  use.  Often,  simply  correcting  the  rate  for  use 
in  future  years  is  all  that  is  considered  necessary  and, 
taking  into  consideration  the  possibility  of  an  inaccurate 
appraisal,  it  is  better  to  do  this  than  to  adjust  the  ac- 
count, except  that  past  estimates  of  depreciation  have 
proven  wholly  inaccurate. 

Repairs  and  Renewals. 

Kepairs  and  Renewals  are,  as  stated,  a  charge  to  Rev- 
enue, either  by  a  direct  charge  during  the  year  in  which 
they  occur;  by  a  charge  of  an  equal  portion  of  the  esti- 
mated amount  to  be  expended  during  the  life  of  an  asset, 
as  outlined  under  plan  "C";  or,  in  cases  where  use 
greatly  depreciates  the  asset,  by  a  certain  amount  per 
unit  of  production. 

Although  the  rule  seems  very  simple,  it  is  often 
hard  to  apply.  This  is  particularly  true  in  the  case  of 
extensive  repairs  which  greatly  increase  the  value  of  the 
article  repaired  not  only  from  an  operating  standpoint 
but  as  an  asset  as  well,  and  the  tendency  is  to  capitalize 
the  expenditure.  It  is  believed  better,  however,  where 
plans  "A"  or  "B"  are  used,  to  charge  the  entire  expendi- 
ture to  Revenue,  unless  the  repairs  involved  amount  to 
practically  redesigning  or  rebuilding,  in  which  case  it 


DEPRECIATION  123 

might  be  well  to  have  the  asset  appraised.  The  book  value 
could  then  be  increased  to  the  appraised  value  and  the 
balance  of  the  expenditure  charged  to  Revenue. 

Of  course,  if  plan  UC"  was  being  used,  the  additional 
expenditure  would  have  no  effect  on  the  annual  charge 
to  Revenue  except,  possibly,  to  increase  it  if  the  repairs 
were  out  of  proportion  with  the  estimate.  If,  in  this 
case,  the  expenditure  entirely  wiped  out  the  amount  that 
had  been  allowed  for  repairing  the  asset  and  resulted  in 
an  increase  in  the  book  value  of  the  asset  which  was  not 
warranted  by  the  actual  conditions,  the  amount  of  the 
expenditure,  which  was  in  excess  of  the  amount  provided, 
should  be  closed  into  Revenue  and  the  annual  charge  to 
Revenue  should  be  adjusted  so  that  in  the  future  a  suf- 
ficient amount  would  always  be  available  to  cover  any 
repairs  that  might  be  necessary. 

Consideration  should  also  be  given  the  effect  of  not 
making  repairs  promptly.  This  undoubtedly  results  in  a 
greatly  increased  charge  to  Revenue  but  it  is  a  matter 
of  scientific  management  rather  than  of  accounting  and 
all  the  accountant  can  hope  to  do  is  -to  see  that  the  re- 
pairs, no  matter  how  great,  are  properly  charged  to  Rev- 
enue during  the  year  they  occur,  as  outlined  above.  Of 
course,  if  the  current  year  would  improperly  suffer  by 
I liis  method  and  if  the  repairs  were  traceable  to  prior 
years,  a  portion  of  the  expenditure  could  be  closed  into 
rndivided  Profits  as  affecting  those  particular  years. 

Obsolescence. 

Undoubtedly  one  of  the  most  uncertain  factors  in  de- 
termining the  proper  charge  for  depreciation  is  that  of 
obsolescence.  It  is  almost  impossible  to  compute,  with 
any  degree  of  accuracy,  the  advance  that  may  be  made 
in  the  construction  of  any  particular  class  of  machine. 


124  ACCOUNTING  PRINCIPLES 

It  is  also  almost  impossible  to  decide,  even  approximately, 
how  long  any  particular  mechanical  device  will  provide 
the  required  output  to  keep  up  with  the  demands  or 
whims  of  the  trade.  Take  the  case  of  an  electrical  ma- 
chine, it  might  answer  the  requirements  for  many  years 
but  the  advent  of  a  new  or  improved  machine  or  an  un- 
usual increase  of  business,  might  make  it  imperative  that 
it  be  discarded;  or  take  the  case  of  a  typewriter,  there 
are  already  a  number  of  devices  patented  and  in  operation 
which  are  intended  to  supersede  it.  No  one  can  tell  just 
when  they  will  be  able  to  satisfy  the  public  but  sooner 
or  later  the  manufacture  of  typewriters  will  cease  and 
provision  should  be  made  so  that  at  that  time  nothing 
will  remain  on  the  books  of  the  manufacturer  to  repre- 
sent the  working  value  of  his  machinery  unless,  by  chance, 
he  could  hope  to  be  able  to  turn  it  to  good  use  in  man- 
ufacturing the  new  article. 

A  consideration  of  the  rapid  advance  of  this  particu- 
lar article  leads  us  to  believe  that  much  of  the  profit 
that  has  been  made  in  their  manufacture  and  sale  has 
been  eaten  up  by  the  purchase  of  new  machinery,  espe- 
cially adapted  to  making  new  and  improved  parts,  to  re- 
place other  machines  even  before  they  are  worn  out,  and 
in  the  decrease  in  the  value  of  stock  owing  to  the  im- 
provements on,  and  the  production  of,  later  models. 

Provision  should  have  been  made  for  this  in  the  early 
years  of  the  industry  and,  if  it  was  not,  little  can  be 
hoped  for  in  current  years  in  the  way  of  a  satisfactory 
profit. 

The  rapid  strides  made  in  the  construction  of  these 
machines  signal  the  early  appearance  of  a  perfect  article 
which,  if  history  repeats  itself,  will  almost  immediately 
give  way  to  some  other  article,  built  on  different  lines, 
which  will  do  the  work  in  half  the  time  or  without  the 


DEPRECIATION  125 

effort.     In  the  meantime  provision  must  be  made  to  care 
for  this  contingency. 

An  article  might  also  become  obsolete  in  a  certain 
sense,  so  far  as  the  business  in  concerned,  long  before  it 
becomes  useless  for  the  purpose  for  which  it  was  made. 
rI1i is  occurs  in  the  case  of  fixtures  which  are  attached 
to  leased  property  and  cannot  be  removed  by  the  lessor  at 
the  termination  of  the  lease.  So  far  as  the  lessor  is  con- 
cerned their  life  expires  with  the  lease  and  provision  must 
be  made  to  cover  their  value  before  that  time. 

Abandonment  of  Property. 

In  general,  where  property  is  abandoned,  the  asset 
account  is  reduced  to  the  scrap  value  of  the  property 
and,  if  provision  has  not  been  made  during  the  life  of  the 
asset  to  cover  its  entire  obsolescence  and  depreciation,  the 
difference  is  closed  into  Undivided  Profits  or  Surplus  as 
chargeable  against  prior  years. 

Sale  of  Property. 

At  the  time  of  sale  of  a  portion  of  the  property,  an 
element  of  doubt  exists  as  to  the  proper  entries  to  make 
in  adjusting  the  accounts  representing  the  assets.  Usually 
the  property  account  represents  the  purchase  price  of  the 
assets  and  some  subsidiary  account  represents  the  deduc- 
tions that  have  been  provided  for.  In  general,  the  pro- 
vision for  depreciation,  etc.,  has  been  in  accordance  with 
some  well  defined  rule  during  the  life  of  the  assets,  there- 
fore, in  ascertaining  the  book  value  of  the  particular  as- 
set sold,  it  is  possible  to  ascertain  its  cost  price  and, 
based  on  its  life  and  the  rate  adopted  for  depreciation, 
its  reduced  value.  Any  difference  that  exists  between  the 
book  value  and  the  sale  price  should  be  closed  into  Sur- 
plus or  Undivided  Profits  on  the  theory  that  either  too 


126  ACCOUNTING  PRINCIPLES 

much  or  too  little  has  been  allowed  for  depreciation  and 
obsolescence. 

If  the  property  of  a  concern  consists  of  many  articles 
and,  if  owing  to  their  great  number  and  variety  the  above 
outline  becomes  impracticable,  it  is  suggested  that  a  record 
be  kept  of  each  article  in  a  Plant  Ledger  and  that  the 
record  cover  the  purchase  price,  repairs,  and  deprecia- 
tilon  and,  after  its  sale,  the  sale  price  and  adjustments 
necessary  to  close  the  account.  Such  a  book  is  most  val- 
uable in  determining  the  proper  rates  for  depreciation, 
the  relative  values  of  different  brands  of  articles,  etc.,  and 
is  explained  more  fully  under  a  more  appropriate  heading. 

Wasting  Assets. 

Although,  undoubtedly,  every  visible  asset  is  subject 
to  depreciation,  certain  undertakings,  except  possibly  un- 
der certain  -  conditions,  do  not  consider  it  necessary  to 
allow  for  this  depreciation  in  their  accounts.  This  par- 
ticularly refers  to  the  accounts  of  non-permanent  under- 
takings such  as  those  operating  a  single  ship,  a  mine,  a 
quarry  or  a  patent  covering  a  novelty  which  may  or  may 
not  please  the  public. 

In  each  of  these  cases  the  undertaking  exists  only 
during  the  life  of  the  asset  and  may  end  at  any  time  owing 
to  a  fad  of  the  public,  an  accident  or  the  exhaustion  of 
the  material  on  which  to  work.  As  no  provision  could 
be  made  with  any  great  degree  of  accuracy  to  cover  the 
portion  of  the  value  that  should  be  charged  against  each 
period  and,  as  the  undertaking  is  to  cease  with  the  life 
of  the  asset,  it  is  contended  that  no  good  can  be  accom- 
plished by  withholding  any  portion  of  the  income  to  pro- 
vide fo.r  replacements,  although,  usually,  it  is  considered 
proper  to  provide  for  repairs  and  renewals,  or  the  de- 
preciation of  machinery  which  may  require  replacing  dur- 
ing the  life  of  the  undertaking. 


DEPRECIATION  127 

The  principal  objection  to  the  plan  of  -ignpring  the 
decrease  in  value  lies  in  that  stockholders  receive  as 
dividends  not  only  the  profits  of  the  undertaking  but  a 
portion  of  the  capital  as  well  and,  as  they  are  unable  to 
determine  the  amount  of  each,  their  tendency  is  to  con- 
sider the  entire  dividend  as  profit  and  to  treat  it  accord- 
ingly with  a  consequent  impairment  of  their  capital. 

The  usual  objection,  raised  in  connection  with  pro- 
viding for  depreciation  or  exhaustion  in  connection  with 
such  undertakings,  is  that  if  provision  is  made,  it  results 
in  the  accumulation  of  a  considerable  sum  of  money  in 
the  company  which  is  not  required  by  the  undertaking 
and  which  could  be  more  profitably  used  by  the  stock- 
holders. 

In  connection  with  such  undertakings,  we  believe,  spe- 
cial mention  should  be  made  of  the  necessity  of  providing 
for  depreciation  or  exhaustion,  even  in  the  case  of  mines, 
ships,  etc.,  where  the  undertaking  is  to  be  of  a  permanent 
character.  That  is  if,  after  the  one  mine  is  exhausted  or 
during  its  life,  other  mines  are  to  be  purchased  or  if  the 
organization  expects  to  continue  to  operate  and  to  ac- 
quire more  property  and  cannot  be  said  to  be  organized 
for  the  single  purpose  of  working  the  one  asset,  provision 
should  be  made  for  the  depreciation  or  exhaustion  of  the 
assets  comprising  their  property  the  same  as  of  other 
lines  of  business. 

\\V  also  wish  to  state  that,  in  our  opinion,  the  term 
depreciation  hardly  applies  to  the  decreases  in  the  value 
of  mines,  quarries  or  timber  caused  by  the  removal  of  ma- 
terial. In  these  cases,  it  seems  to  be  a  question  of  de- 
termining the  proportionate  cost  of  the  material  removed 
rather  than  the  depreciation.  To  be  sure,  depreciation 
in  its  broadest  sense  'means  any  decrease  in  value  but,  as 
applied  to  accounting,  its  use  is  restricted  to  decreases 


128  ACCOUNTING  PRINCIPLES 

due  to  wear  and  tear,  obsolescence  or  effluxion  of  time, 
and  none  of  these  apply  in  the  cases  mentioned  above.  If 
they  do  depreciate,  it  is  in  the  same  sense  that  a  cargo  of 
wheat  depreciates  when  a  portion  is  sold  rather  than  as 
a  machine  would  depreciate  through  use  or  a  copyright 
through  expiration  of  time ;  hence,  it  seems  impractical  to 
try  to  apply  the  rules  of  depreciation. 

Rates  on  Different  Objects. 
Land  and  Appurtenances. 

Land  may,  in  general,  be  presumed  to  maintain  its 
value  and  cannot  be  subject  to  depreciation.  In  the  case 
of  farm  lands  consideration  should  be  given  the  cost  of 
recuperating  the  land  from  the  income  derived  through 
the  crop.  Except,  in  rare  cases,  this  is  considered  as  a 
direct  charge  against  the  current  year's  operations. 

Orchards  require  replacing  from  time  to  time  either 
on  account  of  the  age  of  the  trees  or  on  account  of  the 
demand  for  new  or  improved  varieties  but,  as  the  new 
trees  may  usually  be  brought  to  bearing  before  the  older 
ones  are  removed,  the  expense  is  not  considered  sufficiently 
large  to  make  allowance  for,  except,  possibly,  to  spread  it 
over  a  few  years'  earnings.  Expenses  incurred  in  bring- 
ing the  original  trees  into  bearing  may  properly  be  capi- 
talized. 

Fences,  sidewalks,  etc.,  depreciate  and,  if  they  amount 
to  any  very  great  sum,  should  not  be  included  with  the 
cost  of  the  land.  Their  life  varies  from  five  to  twenty- 
five  years  according  to  the  ability  of  the  material  of 
which  they  are  constructed  to  withstand  the  weather  and 
they  should  be  depreciated  accordingly. 

Buildings  require  a  separate  account  on  account  of 
the  different  rate  of  depreciation  and,  like  the  other  ar- 
ticles mentioned,  vary  greatly  in  the  length  of  their  life, 


DEPRECIATION  129 

depending  on  the  material  used,  the  manner  of  workman- 
ship, the  modernness  of  their  equipment  and  the  stability 
of  i  lie  town  in  which  they  are  constructed.  Under  normal 
conditions  the  minimum  life  may  be  estimated  as  approx- 
imately 25  years  for  frame  buildings  and  50  years  for 
the  more  substantial  structures.  The  maximum  life  may 
exceed  100  years  but  it  is  doubtful  if  a  greater  term 
should  be  allowed  for  on  account  of  obsolescence  and 
contingencies  which  cannot  be  foreseen. 

Fixtures  attached  to  the  land  during  a  tenancy  should 
be  written  off  during  the  life  of  the  lease  if  they  may  be- 
come the  property  of  the  landlord  at  the  expiration  of 
that  time  or  if  they  are  of  such  a  nature  that  it  would 
be  impracticable  to  remove  them. 

Leaseholds. 

The  initial  cost  of  a  lease  and  all  expenditures  made 
for  property  that  will  revert  to  the  landlord,  as  well  as 
the  interest  on  the  lease  for  the  entire  period  should  be 
spread  in  equal  portions  over  the  life  of  the  lease.  If 
there  is  a  possibility  of  a  claim  arising,  at  the  expiration 
of  the  lease,  for  damages  or  for  replacing  the  premises  in 
their  original  condition  a  portion  of  the  earnings  should 
be  set  aside  from  year  to  year  to  make  up  the  loss. 

In  many  cases  it  is  considered  proper  to  invest  an 
amount  each  year  equal  to  that  portion  of  the  total  cost 
of  the  lease  which  is  chargeable  to  that  year  so  that  at  the 
expiration  of  the  lease  a  fund  will  be  available  with 
which  to  acquire  another  lease  if  desired.  A  fund,  so 
provided,  is  usually  placed  at  interest  and  it  is  not 
unusual  to  find  that  this  interest  is  allowed  to  affect 
the  annual  charge  to  Revenue.  The  cost  and  expenses 
incidental  to  the  lease  are  not  changed  by  the  invest- 
ment of  a  fund  to  provide  additional  finances  should 


130  ACCOUNTING  PRINCIPLES 

they  be  required,  therefore,  no  change  should  be  made 
in  the  charges  to  Eevenue  during  the  period  on  that 
account. 

Machinery. 

The  active  life  of  machinery  varies  from  five  to  forty- 
years;  electrical  machinery  usually  being  possessed  of 
a  very  short  life  owing  to  rapidly  changing  conditions, 
while  such  articles  as  lathes  seem  to  be  practically  in- 
destructible and  are  not  affected  very  greatly  by  obsoles 
cence.  Boilers  last  from  8  to  15  years,  depending  on  the 
pressure  under  which  they  operate  and  the  water  used. 
Engines  are  of  greater  life,  except  those  of  the  gasoline 
or  naptha  type  which  depreciate  very  rapidly.  Shafting, 
etc.,  is  rapidly  being  replaced  by  motors  to  allow  the  cost 
of  operation  to  be  more  accurately  recorded  and  to  elim 
inate  the  upkeep  of  belting  and  boxes  and  also  the  loss 
of  power  incident  to  keeping  the  shaft  in  operation  and 
in  readiness  even  though  the  machine  itself  may  not  be 
required.  It  therefore  requires  a  considerable  reduction 
for  depreciation. 

Equipment. 

On  both  office  and  factory  equipment  the  allowance 
for  depreciation  is  usually  from  10%  to  121/2  %  on  de- 
creasing balances,  but  it  is  doubtful  if  this  is  sufficient. 

The  possibility  of  loss  resulting  through  the  expiration 
of  a  lease  should  be  given  consideration  and  any  articles 
that  it  would  not  be  practicable  or  possible  to  move 
should  be  stated  in  a  separate  account. 

Horses. 

The  care  and  attention  that  an  animal  receives  and 
the  conditions  under  which  it  labors  are  such  prom- 
inent factors  in  the  depreciation  of  horses  that  it  is  gen- 


DEPRECIATION  131 

orally  considered  advisable  to  have  them  re-valued  from 
period  to  period. 

Tools. 

The  loss  on  loose  tools  through  breakage  and  theft  is 
so  great  that  it  is  usually  considered  proper  to  re-value 
them  from  time  to  time.  The  decrease  in  value  should  be 
charged  against  the  current  year's  operations  in  lieu  of 
an  annual  charge  for  depreciation. 

Patterns. 

Patterns,  if  made  for  a  particular  job,  should  become 
a  portion  of  the  cost  of  that  job.  Stock  patterns  should 
be  inventoried  at  cost  but  great  care  should  be  given  to 
sorting  and  setting  aside  those  which  are  worn  out  or 
are  obsolete.  The  most  popular  plan  seems  to  be  to  keep 
a  record  of  each  pattern  and  the  date  on  which  it  was 
used. 

Those  which  are  not  in  use  or  have  not  been  used  for 
a  reasonable  time  should  be  inventoried  as  no  value.  The 
reduction  made  in  the  account  at  the  time  of  the  inven- 
tory represents  the  depreciation  for  the  period  under  re- 
view. 

Although  patterns  are  usually  inventoried  at  cost, 
there  is  often  a  deduction  made  to  represent  the  wear  and 
tear  thereon  but  it  seems  that  as,  after  the  first  plan  or 
pattern  has  been  prepared,  another  can  usually  be  made 
so  easily  from  it  no  allowance  should  be  required. 

Patents. 

Patents  should  be  entirely  written  off  during  their 
life.  If  the  patent  covers  some  article  the  sale  of  which 
is  dependent  on  the  whims  of  the  public  it  should  be 
closed  out  against  the  income  of  the  first  year  or  two. 


132  ACCOUNTING  PRINCIPLES 

The  possibility  of  being  compelled  to  protect  the 
patent  in  the  courts  always  exists  and  it  is  advisable 
to  provide  for  this  contingency  by  writing  off  consid- 
erably more  than  a  proportionate  part  of  the  cost  each 
year.  Expenditures  made  in  quieting  the  title  or  pro- 
tecting the  monopoly  relate  back  to  the  date  of  the 
grant  and,  we  believe,  may  properly  be  capitalized  after 
charging  Surplus  with  that  portion  of  the  expenditure 
which  relates  to  prior  years. 

Where  the  patent  is  being  operated  as  a  "Wasting 
Asset,"  it  is  not  considered  necessary  to  write  off  any 
portion  of  the  cost  from  year  to  year. 

Goodwill. 

Goodwill  differs  from  Patents  and  Copyrights  in  that 
it  is  not  terminable.  It  does  not  depreciate  and  no  de- 
duction need  be  made. 

Residual  Values. 

Residual  Value  of  a  Machine  Costing  $100.00,  Reduced  at  Various  Rates  Annually 

-  ~     5.00     3.00 


TIM 

lye 

2  ye 
3 
4 
5 
6 
7 
8 
9 
10 
20 
30 
40 
50 
60 
70 
80 
90 
100 

E 

ar. 
ars 

.    50.00   60.00  66.67   70.00  75.00  80.00  85.00  87.50  90.00  92.50  95.00  97.00 
25.00   36.00   44.44   49.00   56.25   64.00   72.25   76.56   81.00   85.56   90.25   94.09 
.    12.50   21.60   29.62   34.30   42.20   51.20   61.42   66.99   72.90   79.15   85.74   91.27 
...      6.25    12.96   19.75   24.01   31.65   40.96   52.21   58.61   65.61    73.21   81.45   88.53 

.      3.12     7.77   13.20   16.81   23.57   32.76  44.38   51.29  59.05   67.72   77.38   85.87 
1.56     4.66     8.80   11.77   17.82   26.20   37.72  44.88  53.14   62.64   73.51   83.30 
.78     2.80     5.87     8.23    13.37   20.96   32.06   39.26   47.83   57.94   69.83   80.80 
1.68     3.91     5.77    10.02    16.76   27.25   34.35   43.05   53.60   66.34   78.37 
1.00     2.61     4.03     7.52    13.40   23.17  30.06  38.74  49.58  63.02   76.02 
1.74     2.83     5.65   10.72   19.69   26.30  34.87  45.86  59.87  73.74 

.31      1.15     3.88     6.94   12.16   20.93   35.85   54.37 
.76     1.84     4.24     9.60  2J.46  40.09 

1.48     4.39    12.85   29.56 

2.00     7.69   21.80 

4.60   16.08 

2.75   11.86 

8.74 

6.45 

4.76 

DEPRECIATION  133 


C.  P.  A.  Questions 

1.  It  has  been  stated  that,  in  a  given  year,  the  Plant 
of  a  business  cannot  be  depreciated  because  a  sufficient 
profit  has  not  been  made.    Is  this  correct?     (XXX.) 

2.  Distinguish  between  Depreciation  and  the  Fluctua- 
tion of  assets.     (XXX.) 

3.  Define  obsolescence.    (XXX.) 

4.  One    author    claims   that    depreciation    is    not   a 
charge  to  manufacturing  as  it  goes  on  independent  of 
operation.    Discuss  the  assertion.     (XXX.) 

5.  May  depreciation  be  waived  on  the  theory  that  it 
is  fully  covered  by  the  appreciation  of  fixed  assets?     Is 
there  any  sound  argument  in  favor  of  this?     (XXX.) 

(I.  How  are  the  depreciation  charges  often  verified? 
(XXX.) 

7.  A  few  years  ago  a  great  many  undertakings  greatly 
reduced  their  output  owing  to  financial  difficulties.  Should 
they  still  charge  the  full  rate  of  depreciation?     (XXX.) 

8.  Is  Depreciation  in  the  nature  of  an  expense  item 
or  is  it  a  disposition  of  part  of  the  profits,  like  a  divi- 
dend?    (XXX.) 

9.  What  conditions  would  influence  you  in  fixing  the 
rate  of  depreciation  on  buildings,  machinery  and  tools, 
fixtures  and  patterns?     (N.  Y.) 

10.  Should  depreciation  be  written  off  the  accounts 
of  a  corporation  whose  properties  are  of  a  wasting  na- 
ture, such  as  a  quarry  or  a  mine?    Give  reasons.    (Mich.) 

11.  If  you  were  asked  to  give  advice  concerning  the 
proper  rates,  per  cent.,  to  be  adopted  in  providing  in  the 


134  ACCOUNTING  PRINCIPLES 

accounts  for  depreciation  on  buildings,  machinery,  tools, 
etc.,  what  would  you  recommend?     (N.  Y.) 

12.  Describe  at  least  two  methods  of  estimating  de- 
preciation for  a  manufacturing  firm;   state  the  advan- 
tages or  disadvantages  of  each  and  show  how  the  entries 
should  be  made  in  the  books. 

13.  Mention  the  various  things  that  require  consid- 
eration when  endeavoring  to  ascertain  the  proper  rate  of 
depreciation.     ( XXX. ) 

14.  In  determining  the  result  of  the  operations  of  a 
company  whose  business  requires  the  use  of  a  large  num- 
ber of  tools  and  implements,  what  general  rule  would 
you  consider?     (111.) 

15.  What  is  meant  by  the  term  "Depreciation?"    Is 
it  the  same  as  ordinary  wear  and  tear?     (XXX.) 

16.  Illustrate  the  difference  between  Depreciation  at 
8%  annually  on  the  original  value  of  Plant  and  Machin- 
ery, and  10%  annually  on  the  reducing  book  value,  say, 
at  the  end  of  five  years  on  f  10,000.00.     (XXX.) 

17.  (a)     What  is  the  meaning  of  depreciation  and 
how  does  it  affect  the  net  results  of  a  business? 

(b)  Where  a  plant  is  purchased  as  a  whole,  without 
a  valuation  of  its  different  parts,  how  would  you  provide 
for  depreciation?  (Penn.) 

18.  An  examination  of  the  minutes  and  other  rec- 
ords of  the  books  of  a  corporation,  preceding  an  audit, 
discloses  that  a  re-valuation  of  its  buildings,  plant  and 
machinery  had  been  made  by  expert  appraisers  called  in 
for  the  purpose.     The  report  of  these  appraisers  states 
that  the  values  as  determined  by  them  were  greater  than 
those   disclosed  by   the   books.     Should   such   increased 
value  be  entered  on  the  books  of  the  corporation?    (N.  Y.) 


DEPRECIATION  135 

19.  What  kind  of  expenditures  of  a  manufacturing 
business  would  you  classify  as  being  in  the  nature  of 
maintenance  and  repairs  of  equipment,  machinery,  and 
plant,   and   what  would   constitute  actual   betterments? 
How  should  such  expenditure  be  dealt  with  on  the  books? 
(N.  Y.) 

20.  Explain  fully  and  accurately  the  consequences  of 
omitting  to  provide  for  Depreciation.     (XXX.) 

21.  It  is  contended  that  it  is  unnecessary  to  write  off 
depreciation  on : 

a.  Freehold  premises; 

b.  Plant  and  Machinery ; 

provided  that  they  are  maintained  in  a  full  state  of  effi- 
ciency out  of  revenue.  Give  briefly  your  own  views  on 
this  subject.  (111.) 

1*-.  During  the  past  fiscal  year  a  concern  under  audit 
has  not  shown  a  profit  sufficient  to  justify  paying  a  divi- 
dend. The  manager,  in  order  to  avoid  showing  a  loss, 
disregards  the  usual  depreciation  reserve  charges  for 
structures,  plant,  machinery,  tools  and  implements. 

What  would  be  your  view  as  auditor  under  the  cir- 
cumstances? Give  your  reasons.  (111.) 

23.  Name  some  reason  why  it  is  important  to  keep 
distinct  the  various  items  of  cost  in  the  construction  of 
a  building  containing  boilers,  engines,  shafting,  and  heat- 
ing plant.     In  the  erection  of  the  building  itself,  why 
should  the  cost  of  the  foundations  be  kept  distinct  from 
that  of  the  balance  of  the  building? 

24.  AVhat  would  be  a  fair  allowance  for  depreciation 
per  annum  on  the  following  plant  assets: 

Real  Estate,  including  fences,  sidewalks,  tracks,  etc. 
Buildings   and  building  fixtures — fireproof   construc- 
tion. 


136  ACCOUNTING  PRINCIPLES 

Factory  equipment,  including  benches,  cupboards,  etc. 

Machinery,  both  iron  and  wood  working. 

Fixed  tools,  both  iron  and  wood  working. 

Loose  tools,  both  iron  and  wood  working. 

Power  plant. 

Electric  wriring  and  apparatus — including  dynamos, 
motors,  etc. 

Sprinkler  system  and  fire  equipment. 

Blower  system. 

Office  furniture  and  fixtures,  including  typewriters, 
adding  machines,  graphophones,  multigraphs,  etc. 

Horses  and  mules. 

Wagons,  harness  and  trappings. 

Patterns — iron  and  wood — and  drawings. 

State  your  opinion — for  or  against — the  necessity  of 
providing  for  depreciation  in  a  manufacturing  business. 
(Mich.) 

25.  Note  different  methods  by  which  depreciation  on 
patents,  buildings  and  machinery  may  be  provided  for, 
and  outline  briefly  your  opinion  as  to  the  most  desirable 
course  to  be  adopted.     (111.) 

26.  A  railway  company  leases  the  property  of  an- 
other railway  company  for  a  period   of  50  years   and, 
as   part   of   the   consideration    for   the   lease,   agrees   to 
expend    immediately    $250,000    on    the    leased    property, 
in  order  that  it  shall  have  a  greater  operation  efficiency. 
At  the  termination  of  the  lease  the  property  is  to  be 
returned  to  the  lessor  in  the  same  condition  as  at  the 
time  of  making  the  lease,  subject  to  ordinary  wear  and 
tear.      What   entries,   if   any,   would   you   make   on   the 
books  of  the  lessor  in  respect  to  the  expenditure  of  the 
|250,000,  and  why?    Explain  fully.     (N.  Y.) 

27.  A  company  is  about  to  reduce  its  capital  stock 
so  as  to  wipe  off  past  losses.     It  is  suggested  that  a  fur- 


DEPRECIATION  137 

ther  sum  be  written  off  its  plant  and  machinery  to  antici- 
pate and  provide  for  ordinary  depreciation  and  thus  save 
this  charge  on  profit  and  loss  for  some  years.  What  ob- 
jections, if  any,  are  there  to  this  procedure?  (Adapted 
from  Dicksee's  Advanced  Accounting.) 

28.  Mention  the  various  methods  by  which  deprecia- 
tion of  buildings,  machinery  and  plant  may  be  provided 
for  and  explain  the  result  of  each  method.  (XXX.) 

Ui).  Discuss  the  different  methods  of  dealing  with, 
first,  repairs,  and,  second,  replacements  in  connection 
with  (a)  a  concern  that  writes  off,  annually,  sufficient 
depreciation  to  cover  the  life  of  the  machinery,  and  (b) 
a  concern  where  no  depreciation  is  written  off  and  where 
it  is  claimed  the  machinery  is  kept  as  good  as  new. 

Can  you  name  some  other  reason  why  depreciation 
should  be  considered  in  respect  to  machinery  other  than 
that  of  wear  and  tear?  (111.) 

30.  In  the  machinery  accounts  of  a  firm  whose  books 
you  are  auditing  appear  charges  for : 

(a)  New  parts  to  replace  old  ones  worn  out. 

(b)  Engineer's  salary. 

(c)  Labor  setting  up  new  machinery. 

(d)  Moving  old  machinery  from  one  part  of  the  fac- 
tory and  setting  it  up  in  another. 

Do  you  see  any,  and  if  so,  what  objection  to  these 
charges  being  so  treated?  (Wash.) 

31.  A  company  is  established  for  working  a  patent 
of  which  ten  years  are  unexpired  and  for  which  a  sum 
of  money  has  been  paid.     How  should  the  company  deal 
with  this  asset?     (111.) 

32.  You  are  asked  to  advise  whether  a  company  work 
ing  a  wasting  property  (e.  g.,  a  mine)  should,  before  the 
annual  closing  of  its  books,  make  any  provision  for  the 


138  ACCOUNTING  PRINCIPLES 

estimated  depreciation  of  such  property,  or  whether  it 
should  be  allowed  to  stand  on  the  books  at  its  original 
figure  without  such  provision  being  made.  State  your 
opinion,  giving  reasons.  (Wash.) 

33.  Is  depreciation  of  plant  a  legitimate  element  of  the 
cost  of  goods  produced?     Explain  the  method  employed 
to    keep    plant    in    efficient    condition    out    of    earnings. 
.(N.  Y.) 

34.  What  would  be  the  effect  on  a  statement  of  assets 
and  liabilities  of  failure  to  charge  depreciation  against  the 
following  assets:    (a)  leasehold  buildings,   (b)   fixed  ma- 
chinery,, (c)    loose   machinery,    (d)    horses   and   trucks, 
(e)    patterns   and   molds?     Give   reasons   in   each   case. 
(N.  Y.) 

35.  The  secretary  of  a  manufacturing  corporation  has 
undertaken  to  close  its  books.    The  balance  to  the  credit 
of  the  profit  and  loss  account  is  just  sufficient  to  enable 
the  directors  to  declare  a  small  dividend,  which  they  pro- 
pose to  do.     At  this  juncture  the  services  of  an  account- 
ant are  engaged.     He  finds  that  no  provision  for  depre- 
ciation has  been  made  and  that  all  expenditures  for  re- 
pairs and  renewals,  amounting  to  more  than  the  proposed 
dividend,    have    been    charged  direct  to  plant  account. 
Show  the  nature  of  any  corrective  entries  that  should 
be  made.    What  would  be  the  effect  of  such  entries,  there 
being  no  surplus?     (N.  Y.) 

36.  A  company  leases  for  a  term  of  50  years  certain  un- 
improved property  for  factory  purposes,  paying  a  ground 
rent  therefor  of  fl,000  a  year.     The  company  erects  cer- 
tain buildings  at  a  cost  of  f  40,000  which  are  to  pass  to  the 
owner  of  the  fee  at  the  termination  of  the  lease.    Without 
going  into  the  mathematics  on  the  matter,  state  how  you 
would   treat   the   proposition   in   the  books   of   account. 
(N.  Y.) 


DEPRECIATION  139 

37.  A  salt  company  has  completed  a  manufacturing 
plant,  the  machinery  and  equipment  cost  being  $250,000. 
It  is  assumed  that  because  of  the  nature  of  the  business  the 
entire  machinery  and  equipment  will  have  to  be  replaced 
every  several  years.    In  such  a  case  how  would  you  recom- 
mend that  current  repair  and  maintenance  charges  should 
be  handled.     (Ohio.) 

38.  A  manufacturer  obtains  two  patents  at  the  same 
time  as  follows: 

(a)  He  purchases  outright  a  patent  which  has  only 
ten  years  more  to  run  for  the  sum  of  $5,000,  which  he 
terms  his  patent  No.  1. 

(b)  He  invents  a  contrivance  and  obtains  a  patent 
on  the  same,  the  cost  of  which  he  estimates  at  $12,000 
and  which  he  styles  as  his  patent  No.  2. 

At  the  end  of  three  years  he  expends  the  sum  of 
$5,000  in  defending  his  patent  No.  2,  the  decision  being 
given  in  his  favor.  One  year  later  he  spends  $2,000  in 
a  suit  he  brings  against  a  competitor  for  infringement  of 
liis  patent  No.  1,  which  suit  he  also  wins. 

Without  giving  the  actual  figures,  state  how  you 
would  treat  all  the  above  transactions  and  arrive  at 
a  valuation  of  those  two  patents  six  years  after  he 
obtained  same,  giving  reasons  therefor.  (111.) 

39.  How  should  an  incorporated  coal  company  esti- 
mate the  value  of  its  colliery  in  its  Balance  Sheet  from 
lime  to  time,  first  as  a  Freehold,  secondly  as  a  Lease- 
hold?    (111.) 


CHAPTER  XIV. 

Goodwill 

Goodwill  represents  the  value  of  an  annuity  which  will 
produce  an  amount  equal  to  the  excess  of  profits  that  can 
be  earned  on  account  of  an  established  reputation,  location 
or  monopoly. 

Computing-  Value. 

In  estimating  its  value,  the  life  of  the  annuity  pur- 
chased should  be  carefully  considered.  In  the  case  of 
trading  concerns,  it  is  presumed  that  it  will  last  from 
one  to  six  years  after  a  sale  of  the  property  has  been  con- 
sumated;  in  manufacturing  concerns,  from  one  to  four 
years,  and  in  professional  firms,  one  to  two  years,  subject, 
however,  to  the  effect  of  special  conditions  in  either  case ; 
such  as  the  expiration  of  a  desirable  lease  or  of  patents 
which  have  provided  the  monopoly;  the  degree  of  restric- 
tion placed  on  the  vendor's  future  actions  in  business; 
the  certainty  that  a  deceased  partner  or  manager  will  not 
enter  into  competition  at  some  later  date;  the  fact  that 
the  vendor  is  a  corporation  and  that  there  is  no  assur- 
ance that  its  active  members  will  not  enter  competitive 
organizations;  or  the  degree  of  control  that  the  vendor 
might  be  able  to  exercise  over  the  market  where  a  merger 
is  contemplated  with  a  view  of  affecting  a  monopoly. 

In  determining  the  amount  of  excessive  profits  that 
can  safely  be  anticipated,  it  is  necessary  to  review  the 
history  of  the  concern  to  be  transferred  and  to  use  the 
past  profits  as  a  basis  of  computations.  It  is  very  seldom 
that  the  profits  for  one  period  are  set  up  as  the  amount 
which  may  be  expected  to  accrue  during  another  like 


GOODWILL  141 

period,  but,  rather,  some  normal  period  of  greater  or 
lesser  degree  is  used  as  a  standard  and  the  average  profit 
of  this  particular  period,  per  unit  of  time,  is  presumed 
to  be  the  profit  that  may  safely  be  anticipated  during 
such  succeeding  like  periods  as  may  be  determined  upon 
as  the  life  of  the  annuity,  viz.,  at  the  time  of  the  sale 
of  an  undertaking,  it  may  be  decided  that  the  Goodwill 
transferred  is  equal  to  a  three  years  purchase  of  the 
average  profits  for  the  past  five  years  or,  if  conditions  are 
such  that  a  lesser  period  would  be  the  better  criterion  of 
future  profits,  the  goodwill  might  be  based  on,  say,  a  three 
years'  purchase  of  the  average  profits  of  the  past  eleven 
months,  as  was  reported  recently  in  a  large  merger. 

After  deciding  the  basis  and  the  period  of  apportion- 
ment, it  becomes  necessary  to  determine  just  what  consti- 
tutes the  profits  of  the  period  under  review. 

It  is  clear  that  all  earnings  that  accrue  in  the  ordinary 
course  of  business  should  be  considered  and  that  all 
legitimate  expenses  should  be  placed  on  the  books  and 
should  be  deducted  from  the  earnings  to  determine  the 
actual  results  obtained.  It  is  also  clear  that  any  profits 
or  losses  that  occur  which  are  not  in  the  ordinary  course 
of  business  such  as  losses  through  fire  or  theft,  or  profit 
due  to  the  sale  of  some  portion  of  the  undertaking,  a 
patent,  an  investment,  or  some  fixed  asset,  should  be 
eliminated ;  but  there  are  a  considerable  number  of  items 
which  are  of  a  doubtful  nature  or  which  are  subject  to 
manipulation  and  we  believe  they  should  be  explained. 
The  most  important  of  these  are  items  which  are  a  direct 
result  of  a  lack  of,  or  a  sufficiency  of  capital.  They  are 
Interest  on  Borrowed  Money,  Cash  Discounts  on  Pur- 
chases and  Earnings  on  Outside  Investments. 

Interest  on  Borrowed  Money  only  appears  where  there 
is  a  lack  of  capital,  hence,  when  determining  the  profit 


142  ACCOUNTING  PRINCIPLES 

of  any  particular  period  based  on  normal  conditions,  this 
item  should  be  eliminated. 

Cash  Discount  on  purchases  is  only  possible  when  the 
money  with  which  to  make  prompt  payment  is  available, 
either  as  capital  or  as  borrowed  money.  If  it  is  made 
possible  by  borrowing  money,  the  discount  is  correctly 
an  offset  to  the  interest  paid.  In  any  case,  not  being  an 
element  of  trading,  it  should  be  eliminated  when  deter- 
mining the  future  profits. 

Outside  Investments  to  obtain  revenue  or  to  provide 
for  the  redemption  of  bonds  are  invariably  made  from 
surplus  capital,  therefore  their  earnings  should  not  be 
confused  with  those  of  operation ;  neither  should  unusual 
profits  derived  through  particularly  favorable  conditions 
or  contracts  be  considered. 

Care  should  be  taken  to  see  that  proper  allowance  has 
been  made  for  the  expense  of  management,  for,  as  is  often 
the  case  where  a  person  has  been  managing  his  own  busi- 
ness, there  may  have  been  no  allowance  for  this  and 
profits  would  be  incorrectly  stated  to  that  extent. 

Depreciation  is  probably  the  hardest  of  all  to  deter- 
mine, for,  possibly,  the  initial  value  of  the  property,  as 
stated  by  the  books,  is  entirely  wrong  and  the  final  book 
value  may  be  entirely  different  from  the  value  at  which 
the  property  is  to  be  taken  over  or  at  which  it  has  been 
appraised.  It  is  therefore  a  question  of  exercising  good 
judgment  in  determining  just  what  constitutes  a  proper 
charge  for  depreciation  during  the  period  under  review. 

We  suggest  that,  where  the  opening  account  balances 
are  approximately  correct  as  determined  by  applying  the 
normal  rate  of  depreciation  and  giving  consideration  to 
the  abnormal  conditions  and  the  present  appraised  value, 
the  appraised  value  should  be  set  up  on  the  books  and 
the  difference,  if  any,  applied  as  a  reduction  or  increase 


GOODWILL  143 

of  the  charges  already  made  for  depreciation.  Where 
the  opening  balance  is  undoubtedly  incorrect  the  proper 
depreciation  could  be  ascertained  by  using  the  appraised 
value  as  a  base  and  working  back,  using  the  normal  or, 
if  it  appears  proper,  some  other  rate  as  the  basis  of  the 
charge. 

Existing  Liabilities  on  contracts,  if  they  affect  the 
revenue  of  the  concern,  should  be  considered  also.  This 
refers  particularly  to  such  items  as  the  Liability  existing 
on  Guaranteed  Goods  or  Containers  Returnable  which 
have  been  sold  at  a  profit  but  which  are  redeemable  at  a 
sum  in  excess  of  actual  cost. 

In  guarding  against  the  manipulation  of  the  accounts, 
it  becomes  necessary  to  carefully  watch  all  items  which 
affect  the  earnings  of  the  business,  consideration  being 
given  to  the  effect  of  any  possible  manipulation  on  each 
of  ilic  person's  connected  with  the  business.  In  the  case 
of  a  manager  selling  his  own  business,  if  he  were  inclined 
to  misrepresent  the  status  of  affairs,  it  would  be  by  at- 
tempting to  increase  the  apparent  profit,  either  by  sup- 
pressing proper  charges  or  increasing  the  credits.  If, 
however,  it  was  his  desire  to  purchase  the  business  of 
his  employers,  his  tendency  would  be  to  make  it  appear 
as  poorly  as  possible  and  this  could  be  accomplished  by 
in  flat  ing  the  purchases  and  decreasing  inventories  and 
sales. 

In  the  case  of  Bad  Debts,  a  person  selling  a  business 
could  easily  see  that  they  were  paid  out  of  his  own  pocket 
at  an  opportune  time  so  that  the  losses  would  not  appear 
so  great. 

Sales  are  often  padded  by  including  Sales  on  Ap- 
proval or  Consignment  Sales  and  taking  full  credit  for  the 
anticipated  profit  before  the  actual  sale  is  consumated. 

Kxpenses  may  be  allowed  to  run  on  for  a  considerable 


144  ACCOUNTING  PRINCIPLES 

period  without  giving  them  effect  on  the  books,  conse- 
quently inflating  the  profits  of  the  period. 

Goods  purchased  may  be  included  in  inventories  and 
the  invoices  held  up  or  paid  from  some  other  source  or  the 
stock  may  be  improperly  valued  so  that  an  apparent 
profit  would  be  derived  from  that  source. 

In  all  of  the  cases  mentioned  the  apparent  profits  being 
greater  than  the  actual  profit,  the  purchase  price  of 
Goodwill  would  bear  a  corresponding  increase  to  the  det- 
riment of  the  purchasers. 

It  is  also  possible  that  a  portion  of  the  undertaking 
is  to  be  retained  by  the  vendors  and  that  this  portion 
has  produced  a  portion  of  the  profit.  This  will  not 
accrue  to  the  vendees  and  allowance  should  be  made 
therefor. 

After  having  found  the  amount  of  profits  that  can 
safely  be  anticipated  in  the  future,  we  deduct  an  amount 
to  represent  the  normal  earning  capacity  of  the  money 
invested.  Any  sum  that  the  business  produces  in  excess 
of  the  effective  value  of  money  may  be  considered  as  the 
amount  of  the  annuity  which  is  being  transferred  in  the 
nature  of  Goodwill.  After  having  determined  the  life 
of  the  annuity  and  the  amount  thereof,  it  becomes  an 
easy  matter  to  ascertain  its  present  worth,  which  is  the 
Goodwill  value  of  the  business  transferred. 

In  all  cases  special  attention  should  be  given  the 
articles  of  agreement  to  see  whether  the  Goodwill  is  based 
on  the  actual  profits  or  the  excessive  profits  of  a  particu- 
lar period.  The  latter  method  is  undoubtedly  the  most 
equitable  and  preference  should  be  given  it  whenever  pos- 
sible, but  a  much  longer  period  should  be  used  than  where 
the  entire  profits  before  deducting  interest  on  capital 
form  the  basis  of  computations. 

Goodwill  is  intended  to  represent  the  value  of  the  ex- 


GOODWILL  145 

cessive  profits  that  will  accrue  on  account  of  being  al- 
ready established  and  of  possessing  those  qualities  which 
tend  to  attract  business  and  to  build  up  profits.  As  stated 
under  Capital  and  Revenue,  any  expenditures  incurred  in 
starting  a  business  or  bringing  it  up  to  a  profit  producing 
stage  may  be  capitalized.  Goodwill,  then,  if  a  portion  of 
the  purchase  price  of  a  business  or  if  it  is  the  result  of 
expenditures  made  in  bringing  it  up  to  the  profit  bearing 
point,  may  properly  be  placed  on  the  books  as  a  Capital 
Asset.  If,  however,  Goodwill  is  estimated  to  have  accrued 
on  account  of  a  long  period  of  prosperity  or  extensive  ad- 
vertising after  the  business  has  been  running,  it  could  not, 
properly,  be  placed  on  the  books  as  such,  but  in  the  case 
of  the  advertising,  there  would  be  no  harm  in  spreading 
the  expenditure  of  any  one  period  over  a  number  of 
periods,  provided  that  the  entire  amount  is  wiped  out 
during  the  time  that  the  business  could  expect  to  profit  by 
the  expenditure. 

Nothing  could  possibly  be  gained  by  writing  up  a 
Goodwill  account,  for,  surely,  no  business  could  be  made 
more  valuable  by  simply  including  this  account  in  the 
books  and  its  inclusion  would  not  make  the  accounts  more 
correctly  stated,  in  fact,  they  would  be  incorrectly  stated 
to  the  extent  that,  in  the  generally  accepted  use  of  the 
term,  it  is  presumed  to  represent  the  purchase  price  of 
Goodwill,  whereas  in  this  case  it  only  represents  an  arbi- 
irary  value  ilia  I  has  been  placed  upon  it.  Furthermore, 
no  profit  can  properly  be  taken  on  any  article  until  a  sale 
results.  The  writing  up  of  Goodwill  gives  effect  to  an 
anticipated  profit  which  may  be  mistaken  for  a  legitimate 
profit  and  result  in  a  fictitious  dividend  to  the  detriment 
of  the  concern. 

In  rhe  case  of  the  withdrawal  of  a  partner,  there  is 
often  a  payment  made  him  to  represent  his  share  of  the 


146  ACCOUNTING  PRINCIPLES 

Goodwill  of  the  firm.  The  Goodwill  account  may,  under 
this  condition,  be  written  up  to  the  amount  his  share  rep- 
resents. No  attempt  should  be  made  to  place  an  amount 
on  the  books  to  represent  the  total  value  of  all  the  indi- 
vidual partner's  interests  in  the  Goodwill  for  only  the  one 
portion  has  been  purchased  by  the  members  of  the  new 
firm.  To  illustrate,  "A,"  "B"  and  "C"  have  been  conduct- 
ing a  business,  profit  divided  equally.  "C"  decides  to 
retire  and  it  is  concluded  to  allow  him  f  10,000.00  as  his 
share  of  the  Goodwill. 

The  Goodwill  account  should  be  written  up  to 
110,000.00  and  a  like  amount  credited  to  "C's"  Capital 
account  in  preference  to  placing  the  Goodwill  at  f  30,000.00 
and  crediting  each  partner  with  his  portion. 

To  summarize,  Goodwill  may  be  increased  on  the 
books:  (a)  at  the  time  of  the  acquisition  of  some  going 
concern  that  is  to  become  a  portion  of  the  business;  (b) 
during  a  period  of  incipiency  to  represent  expenditures 
incurred  in  building  up  the  business;  or  (c)  to  give  effect 
to  the  proportionate  Goodwill  value  of  a  partner's  interest 
which  is  purchased  by  other  partners. 

Where  a  number  of  concerns  have  merged  their  inter- 
ests and  are  consolidated  into  one  corporation,  there  is 
usually  considerable  doubt  as  to  the  amount  at  Avlrich 
Goodwill  should  be  placed  on  the  books.  The  proper  plan, 
if  this  element  of  doubt  exists,  is  to  appraise  the  assets 
and  to  set  up  the  balance  of  the  purchase  price  as  Good- 
will, provided  that  the  purchase  price  as  stated,  repre- 
sents cash  or  like  value.  If  the  purchase  price  is  paid 
in  stock  of  an  indefinite  value,  an  attempt  should  be  made 
to  ascertain  the  actual  value  and  to  adjust  the  property 
and  Goodwill  accounts  accordingly,  throwing  the  balance 
into  Discount  on  Stock.  The  majority  of  the  stockholders 
object  to  this  mode  of  procedure  and  prefer  that  the  en- 


GOODWILL  147 

tire  stock  be  placed  on  the  books  as  fully  paid.  Stock, 
however,  cannot  be  made  fully  paid  by  simple  bookkeeping 
entries  and  if  the  stock  is  to  appear  as  fully  paid  in  the 
books,  care  should  be  taken  to  have  the  minutes  cover  the 
transfer  fully,  including  the  valuation  at  which  each 
object  is  transferred,  then  the  bookkeeper  can  do  no 
better  than  record  the  items  as  he  finds  them. 

To  eliminate  this  uncertainty  of  values  at  the  time  of 
transfer;  to  satisfy  the  stockholders  and  to  equalize  the 
earnings  of  various  concerns  at  the  time  of  consolidation, 
it  is  desirable  to  issue  fully  paid  cumulative  preferred 
stock  of  equal  value,  or  nearly  so,  in  exchange  for  the 
tangible  assets  taken  over,  and  to  issue  common  stock  to 
each  concern  or  individual  of  an  amount  equal  to  the 
capitalized  value  of  his  earnings  which  are  in  excess  of 
the  interest  value  of  the  capital  invested. 

As  an  illustration:  "A,"  UB"  and  "C"  corporations 
are  to  consolidate.  Their  capitals  are  $60,000,  $80,000 
and  $100,000,  and  their  average  net  earnings  $10,000, 
$8,000  and  $6,000,  respectively.  Provide  stock  and  ar- 
range an  equitable  apportionment  thereof. 

To  care  for  the  tangible  assets  turned  over,  we  will 
provide  $240,000  (dollar  for  dollar,  stock  for  property) 
6%  Cumulative  Preferred  Stock.  To  care  for  the  Good- 
will we  will  ascertain  the  amount  of  stock  the  companies 
are  entitled  to  as  the  capitalized  value  of  their  excess 
earnings,  and  distribute  it  accordingly.  The  minimum 
desired  rate  of  earnings  we  may  take  as  6%,  as  in  com- 
pany "C,"  hence  any  amount  earned  by  either  company 
in  excess  of  6%  may  be  capitalized  as  Goodwill.  We  find 
"A"  has  earned  $6,400  and  "B"  $3,200  per  year  in  excess 
of  the  6%  on  their  capital,  which  amounts  we  will  capital- 
ize at  5%,  giving  a  Goodwill  value  of  $128,000  and  $64,000 
respectively. 


148  ACCOUNTING  PRINCIPLES 

The  common  stock  so  issued  should  be  entitled  to  a 
dividend  equal  to  the  rate  used  in  capitalizing  the  earn- 
ings, i.  e.,  5%,  after  providing  for  the  cumulative  divi- 
dend of  6%  on  the  preferred  stock.  Dividends  in  excess 
of  these  sums  should  be  a  matter  of  special  agreement, 
but  in  this  case  it  would  seem  that  an  apportionment  of 
a  like  amount  between  the  Common  and  Preferred  Stock 
would  be  equitable. 

Our  capitalization  would  be: 

6%  Cumulative  Preferred  Stock,  entitled  in  addi- 
tion to  one-half  of  all  earnings  after  5%  has 
been  paid  on  the  Common  Stock $240,000 

Common  Stock  entitled  to  5%  dividend  after  6% 
has  been  paid  on  the  Cumulative  Preferred  and 
one-half  of  all  excess  earning  remaining 192,000 


A  total  of ....$432,000 

Earnings  of,  say,  $43,200,  would  be  distributed  as  fol- 
lows: 

Regular  Dividends: 

Cumulative  Preferred  Stock,  6%  on 

$240,000.00  $14,400.00 

Common  Stock,  5%  on  $192,000.00  9,600.00 


$24,000.00 

Special  Dividends  (Balance  divided  equally): 
Cumulative  Preferred  Stock,  4%  on 

$240,000.00  $9,600.00 

Common  Stock,  5%  on 
$192,000.00  9,600.00     19,200.00  $43,200.00 


Provision  should  also  be  made  to  give  the  Preferred 
Stock  preference  as  to  capital  so  that,  in  case  of  dissolu- 
tion the  tangible  investment  would  be  cared  for  first,  and 
that  any  sum  in  excess  thereof  would  be  distributed  the 
same  as  earnings,  otherwise  "C's"  tangible  property  may 
be  used  to  pay  "A's"  or  "B's"  intangible  Goodwill,  thereby 
working  a  hardship  on  "C." 


GOODWILL  149 

Writing  Off  Goodwill. 

Goodwill,  if  placed  on  the  books  at  a  proper  valuation 
and  in  a  proper  manner,  is  a  Capital  Asset.  As  outlined 
in  the  previous  chapters,  a  mere  fluctuation  in  the  value 
of  a  Capital  Asset  may  be  ignored,  hence,  so  long  as  Good- 
will cannot  be  consumed  in  the  business  and  is  not  sub- 
ject to  depreciation  like  the  more  tangible  assets,  it  is 
unnecessary  to  amortize  or  otherwise  reduce  its  book 
value. 

The  writing  off  of  Goodwill  creates  a  Secret  Reserve 
to  the  extent  that  Capital  Assets  will  be  decreased  at 
the  expense  of  either  Surplus,  Undivided  Profits,  or  Rev- 
enue, and  profits  will  be  held  in  reserve  without  their 
existence  being  disclosed  by  the  current  financial  reports. 

BadwllL 

In  the  case  of  the  purchase  of  a  concern,  or  more  par- 
ticularly, where  a  number  of  firms  have  consolidated  and 
whore  certain  of  those  taken  over  have  not  made  a  suffi- 
cient profit  to  pay  for  the  use  of  the  capital  involved  in 
conducting  the  business,  an  equivalent  reduction  must  be 
made  in  the  purchase  price.  This,  then,  in  contra-dis- 
tinction  to  Goodwill,  is  Badwill  and  should  offset  the 
Goodwill  value  taken  over  with  the  other  concerns.  In- 
stead of  giving  effect  to  such  an  account,  however,  it  is 
usual  to  accept  the  minimum  rate  earned  by  either  of  the 
companies,  as  the  basis  of  computations  and  to  distribute 
common  stock  to  the  other  companies  of  an  amount  equal 
to  the  capitalized  value  of  their  earnings  which  are  in 
excess  of  the  minimum  earnings  determined  upon. 


150  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  (a)   Define  Goodwill,     (b)   On  what  basis  should 
Goodwill  be  valued?    (c)  On  what  grounds,  if  any,  can  an 
increase  in  the  value  of  Goodwill  be  justified?     (Wash.) 

2.  A   company   whose   capital    stock   is   $250,000.00, 
divided   into   $100,000.00    6%    non-cumulative    preferred 
shares   and  |150,000.00   common   shares,   begins   its   life 
with  an  excess  of  liabilities  (including  Capital)  over  real 
assets  to  the  extent  of  f  10,500.00,  which  sum  is  debited  to 
Suspense  Account.  During  the  first  few  years  small  losses 
are  made  and  carried  forward  to  the  Profit  and  Loss 
account,  but  finally  sufficient  profits  are  earned  to  wipe 
out  the  losses  of  previous  years  and  leave  a  balance  of 
$16,500.00. 

The  holders  of  the  preferred  stock  claim  that  any  sur- 
plus profit,  after  payment  of  the  preference  dividend 
should  be  used  to  extinguish  the  suspense  account. 

The  holders  of  the  common  stock  claim  that  all  such 
surplus  is  properly  available  for  their  dividend  on  the 
ground  that  the  original  deficiency  carried  to  the  suspense 
account  was  in  effect  a  charge  to  Goodwill. 

Give  briefly  your  understanding  of  Goodwill.  State 
how  you  would  deal  with  it  in  this  case,  and  whether  the 
directors  may  pay  any  dividend  on  the  common  stock. 

(in.) 

3.  When  a  corporation  acquires  a  number  of  plants, 
paying  a  lump  sum  for  each,  is  it  necessary  to  show  on 
the  books  the  proportion  of  the  purchase  price  paid  for 
Goodwill,  and  if  so,  what  would  be  the  proper  method  of 
ascertaining  and  expressing  such  proportion  in  the  ac 
counts?      (N.  Y.) 


GOODWILL  151 

4.  Under  what  circumstances,  if  any,  is  it  in  your 
judgment  permissible  to  increase  or  decrease  the  book 
value  of  Goodwill?     (Wash.) 

5.  In  the  case  of  a  consolidation  of  three  manufac- 
turing concerns,  how  would  you  determine  the  Goodwill 
of  the  consolidated  company?     (111.) 

6.  Under  what  circumstances  is  it  necessary  to  open 
a  Goodwill  account?     What  advantages  are  there  in  al- 
lowing it  to  remain  open  indefinitely  on  the  books?     (111.) 

7.  A  merchant,  who  has  been  in  business  for  twenty 
years,  decides  to  put  a  valuation  on  the  Goodwill  of  his 
business  and  carry  same  as  an  asset  on  his  ledger,  the 
entry  being  to  charge  Goodwill  and  credit  Surplus.    An- 
other merchant  five  years  later  buys  the  entire  business, 
i»  i  eluding  the  Goodwill,  and  after  making  a  careful  in- 
ventory finds  that  the  actual  net  resources  exclusive  of 
Goodwill,  amount  to  f 5,000.00  less  than  the  sum  he  paid 
for  it.    Discuss  the  subject  of  Goodwill  in  respect  to  the 
above  case,  and  state  the  correct  manner  of  dealing  with 
same.     (111.) 

8.  In  auditing  the  books  of  a  corporation  capitalized 
at  |250,000  you  find  that  three  years  previously  they  ac- 
quired the  business  of  a  co-partnership  included  in  which 
was  an  asset  called  Goodwill,  valued  at  that  time  at 
SiTi.OOO,  since  which  the  same  has  not  been  written  down. 
The  average  profits  of  the  corporation  for  the  three  years 
have  been  nine  per  cent  on  the  capitalization.    How  would 
you  treat  the  item  Goodwill?     Give  reasons.     (N.  Y.) 

9.  In  making  an  audit  of  a  firm's  books  for  the  pur- 
pose of  certifying  its  annual  profits  for  a  period  of  years 
and  with  a  view  to  its  conversion  into  a  corporation, 
what  items  of  earnings  and  expenses  should  be  omitted 


152  ACCOUNTING  PRINCIPLES 

which  ordinarily  would  be  properly  included  in  its  regular 
annual  profit  and  loss  account?     (N.  Y.) 

10.  Is   Goodwill   a   fixed   or   floating   asset?     Why? 

(N.  Y.) 

11.  A  firm  resolves  itself  into  a  corporation  in  which 
new  capital  is  interested.     How  would  the  auditor  ascer- 
tain the  value  of  Goodwill?     (N.  Y.) 

12.  The  books  of  the  Mapes  &  Manning  Company, 
manufacturers  of  and  dealers  in  farm  implements,  show 
for   the   past   five   years   net   profits   as   follows:      1906, 
$177,000;  1907,  $143,000;  1908,  $206,000;   1909,  $16,000; 
1910,  $98,000. 

You  are  instructed  by  a  banking  syndicate  to  examine 
the  accounts  of  the  company  and  report  upon  the  profits 
during  the  above  period.  In  the  course  of  your  examina- 
tion you  ascertain  the  following  fact:  Current  Liabili- 
ties were  not  taken  into  the  accounts  as  follows:  Jan. 
1,  1906,  for  new  buildings,  $42,000 ;  accrued  wages,  $5,300 ; 
Dec.  31,  1906,  repair  charges,  $2,600;  accrued  wages, 
$2,900;  Dec.  31,  1908,  merchandise  invoices,  $6,800;  cur- 
rent expenses,  $5,400;  Dec.  31,  1910,  accrued  wages, 
$3,200;  materials  and  supplies,  $4,600;  shop  equipment, 
$8,400. 

On  Dec.  31,  1910  the  company  engaged  two  real  estate 
experts  to  appraise  the  land  and  buildings.  The  lower 
of  the  two  showed  a  present  value  of  $587,000,  and  this 
valuation  was  adopted  by  the  board  of  directors,  who  in- 
structed the  bookkeeper  to  charge  Keal  Estate  Account 
and  credit  Profit  and  Loss  at  the  above  date  with  the  differ- 
ence between  the  foregoing  amount  and  the  book  figures 
of  $560,000. 

A  mortgage  of  $200,000,  bearing  5%  remained  upon 
the  property  during  the  whole  of  the  period  under  revieAV, 


GOODWILL  153 

and  interest  on  this  mortgage  was  charged  before  arriving 
at  the  book  profits. 

Satisfactory  provision  was  made  in  each  year  for  de- 
preciation of  buildings,  machinery,  etc. 

Revise  the  profits  for  each  year  in  accordance  with 
the  above  fact.  (Penn.) 

13.  Goodwill  for  a  large  amount  appears  amongst  the 
assets  of  the  Barchester  Brewery  Company,  Ltd.,  a  com- 
pany formed  during  the  brewery  "Boom."    The  profits  of 
the  company  have  gradually  decreased  during  the  past 
few  years,  and,  in  the  years  ending  June  30th,  1908  and 
1909,  while  the  dividend  was  paid  on  the  preference  shares, 
no  profits  were  available  for  dividends  on  the  ordinary 
shares.    The  balance  at  the  credit  of  the  Profit  and  Loss 
account  for  the  year  ended  June  30,  1910,  was  sufficient 
i  .iltcr  satisfying  the  preference  shareholders)   to  pay  a 
dividend  of  2*/2%  on  the  ordinary  shares.    The  directors 
were  divided  in  opinion  as  to  whether  a  dividend  should 
be  declared  or  the  amount  taken  to  the  credit  of  the 
Goodwill  account.    As  auditor  to  the  company  you  were 
called  in  to  advise  the  directors.     State  briefly  the  views 
you  would  have  submitted  to  the  board.     (Inst.  of  C.  A.) 

14.  A  new  corporation,  "D,"  is  formed  to  purchase 
and    amalgamate    the    business    of  three    corporations, 
"A",  "B"  and  "C"  carrying  on  the  same  class  of  busi- 
ness, at  December  31,  1908. 

There  are  considerable  differences  between  the  capi- 
tals, the  gross  sales,  the  expenses  and  the  net  profits 
of  the  three  corporations.  The  amount  to  be  allotted  to 
each  in  shares  of  the  new  company  for  its  capital  and 
goodwill  is  agreed  to  be  referred  to  you. 

Prepare  a  statement  setting  forth  what  you  consider 
to  be  an  equitable  apportionment  of  the  stock  of  the 
new  concern. 


154  ACCOUNTING  PRINCIPLES 

For  the  purpose  of  class  uniformity,  use  the  follow- 
ing figures : 

"A"  "B"  "C" 

Capital  I  60,000.00  |120,000.00  $180,000.00 

Surplus    30,000.00  40,000.00  45,000.00 

Average  Annual 

Net  Earnings     15,000.00  9,600.00  10,800.00 

(Adapted  from  Illinois.) 


CHAPTER  XV 

Liabilities 

The  accounts  representing  the  liabilities  of  a  concern 
are,  if  they  appear  in  the  books  at  all,  seldom  incorrectly 
stated.  There  is,  of  course,  a  possibility  that,  in  preparing 
statements  showing  the  financial  condition  of  the  concern, 
a  like  amount  of  assets  and  liabilities  may  be  omitted 
as  being  offsets  to  each  other,  and  the  status  of  the  con- 
cern be  misrepresented  to  that  extent,  as  in  case  of  the 
purchase  of  some  particular  asset  on  installments,  the 
equity  possessed  by  the  firm,  only,  being  shown,  while 
the  existing  liability  on  the  balance  of  the  contract  may 
be  omitted  entirely  as  an  offset  to  the  equity  possessed  by 
the  vendor. 

Contingent  Liabilities. 

There  are  a  considerable  number  of  transactions  that 
occur  in  regular  business,  the  effect  of  which  is  not  fully 
realized  at  the  time  the  transaction  occurs  and,  as  a  result, 
no  attempt  is  made  to  record  them  in  the  books.  This 
refers  particularly  to  liabilities  which  are  incurred  but 
which  may  or  may  not  become  a  claim,  contingent  upon 
the  happening  of  some  event.  As  an  example,  take  the 
case  of  a  note  that  has  been  charged  to  the  Bills  Receivable 
Account.  If  it  is  discounted,  the  usual  entry  is  to  credit 
Bills  Receivable  and  debit  Cash  and  Bank  Discount. 
This  entry  immediately  removes  the  note  from  the  ac- 
count and  no  effect  is  given  the  possibility  of  the  note 
being  eventually  dishonored  and  becoming  a  claim  against 
the  business.  The  proper  entry  is  to  debit  Cash  and  Bank 


156  ACCOUNTING  PRINCIPLES 

Discount  and  Credit  Bills  Receivable  Discounted,  then 
when  the  note  matures  and  the  liability  is  found  non- 
existent, the  two  accounts  can  be  adjusted. 

Notes  are  often  given,  guaranteed  or  endorsed,  for 
the  accommodation  of  other  persons,  in  which  case,  the 
persons  accommodated  should  be  charged  with  its  amount 
and  Bills  Payable  credited,  or,  if  the  notes  are  exchanged 
the  entry  would  be  Bills  Receivable  Dr.  to  Bills  Payable. 

Cumulative  Preferred  Dividends  in  arrears  are  another 
form  of  Contingent  Liability,  differing  from  Bills  Receiv- 
able Discounted  in  that,  as  between  the  company  and  the 
preferred  stockholder,  no  liability  exists  until  such  time 
as  a  sufficient  profit  has  been  earned  to  warrant  the 
declaration  of  the  dividend,  but,  from  the  standpoint  of 
the  holders  of  inferior  stocks,  a  liability  exists  in  that 
the  Cumulative  Preferred  Dividends  in  arrears  must  be 
paid  before  anything  can  be  paid  on  their  stock.  This 
item  should  not  be  included  in  the  books  of  the  company 
but  should  appear  appended  to  the  Balance  Sheet  as  a 
footnote. 

The  liability  on  Guaranteed  Goods  or  similar  existing 
contracts  should,  if  there  is  any  possibility  of  it  becoming 
a  claim  of  any  great  proportions,  be  given  effect,  either 
by  setting  aside  a  portion  of  the  revenue  and  including 
the  item  in  the  accounts  proper  or  by  appending  a  foot- 
note to  the  Balance  Sheet — the  former  method  preferred. 

Suits  pending  in  the  courts  should  also  be  given  due 
consideration. 

Capital  Liabilities — Bonds  Payable. 

Considerable  doubt  exists  in  the  minds  of  students,  as 
to  the  advisability  of  placing  bonds  on  the  books  that 
have  been  authorized  but  not  yet  issued.  Much  of  the 
confusion  arising,  no  doubt,  from  the  different  views 
entertained  bv  the  various  accountants  who  have  ex- 


LIABILITIES  157 

pressed  themselves  on  the  subject — certain  of  them  having 
given  preference  to  showing  the  entire  authorized  issue 
on  the  books  and  the  unissued  in  an  offset  account, — 
treating  bonds  the  same  as  they  would  stock, — and  others 
favoring  the  placing  of  them  on  the  books  only  as  they 
are  sold,  depending  upon  some  auxiliary  record  such 
as  a  Bond  Register  for  the  details  of  the  issue. 

The  difference  in  the  principles  involved  between  the 
entries  covering  the  stock  and  the  bonds  is  very  slight, 
possibly  not  enough  to  warrant  a  different  treatment  of 
the  items,  but,  as  from  an  accounting  standpoint,  the 
trouble  seems  to  lie  wholly  in  the  accepted  manner  of 
caring  for  stock,  there  seems  to  be  no  valid  reason  for 
treating  bonds  in  the  same  manner. 

No  liability,  whatsoever,  is  incurred  until  the  bonds 
arc  sold  and,  as  an  auxiliary  record  is  necessary  in  any 
case,  to  contain  the  volume  of  information  required  in 
connection  with  the  issue,  we  prefer  to  only  show  the 
bonds  as  they  are  actually  sold. 

In  connection  with  certain  examination  problems,  it  is 
sometimes  required  that  certain  bonds  be  set  aside  as 
treasury  bonds  for  future  disposition ;  such  a  require- 
ment we  believe  infers  that,  from  the  examiners'  view- 
point, it  is  better  to  treat  the  bonds  the  same  as  stock 
and  in  solving  the  problem  it  is  desirable  to  give  effect 
to  an  Unissued  or  Reserved  Bonds  Account. 

Premium  or  Discount  on  the  issue  should  be  set 
aside  in  a  subsidiary  account  to  adjust  future  interest 
payments. 

The  facts  that  bonds  have  been  certified  by  a  Trust 
Company  does  not,  in  any  way,  affect  the  liability  of  the 
company  or  require  any  entries  in  the  books ;  the  certifi- 
cation being  only  for  the  benefit  of  the  purchasers,  to 
assure  them  that  the  authorized  issue  is  not  exceeded. 


158  ACCOUNTING  PRINCIPLES 

Bonds  that  have  been  taken  over  by  an  underwriter 
are,  in  fact,  sold  and  should  appear  accordingly  in  the 
books. 

Capital  Liabilities — Proprietorship. 

The  principal  features  in  connection  with  the  accounts 
representing  the  proprietorship  have  already  been  dealt 
with  in  Chapter  IV;  we  wish  to  add,  however,  a  few 
words  relative  to  corporation  accounts. 

The  authorized  amount  of  Capital  Stock  of  a  concern 
is,  in  general,  placed  on  the  books  and  the  amount  un- 
issued is  entered  as  Unissued  or  Reserved  Stock,  the 
latter  accounts  being  adjusted  from  time  to  time  as  the 
stock  is  issued. 

If  the  stock  is  divided  into  shares  possessing  different 
privileges,  separate  accounts  should  be  opened  for  each 
portion  designating  them  as  "Common  Stock,"  "Preferred 
Stock,"  "Cumulative  Preferred  Stock,"  "Preferred  Stock, 
Unissued,"  etc. 

The .  profits  arising  are  transferred  to  the  credit  of 
"Undivided  Profits  Account,"  and  later,  upon  the  declar- 
ation of  a  dividend  or  other  action  of  the  directors,  to 
Dividends  Payable  Account,  or,  if  the  profits  are  to  be 
used  for  some  other  purpose,  to  an  account  displaying 
the  eventual  disposition  of  the  profits  as  "Eeserve  for 
Contingencies"  or  "Reserve  for  Extensions."  It  profits 
are  retained  in  the  business  instead  of  being  distributed 
and  if  the  respective  rights  of  different  classes  of  stock- 
holders are  thereby  disturbed  the  amounts  reserved  should 
be  specifically  marked  so  when  it  is  distributed  it  will 
go  to  that  stock  which  was  entitled  to  the  profits  in 
the  first  place. 

The  Surplus  account  is  often  used  to  include  undivided 
profits  but,  as  it  is  also  used  to  include  contributions 


LIABILITIES  159 

made  by  stockholders  in  addition  to  the  par  value  of  their 
stock,  as  in  the  case  of  the  organization  of  a  bank  where 
a  premium  is  paid  on  the  subscription;  or  to  include  the 
excess  of  assets  remaining  after  the  Capital  Stock  has 
been  reduced  without  a  return  of  such  excess  to  the  stock- 
holders, it  is  deemed  better  to  use  the  "Undivided  Profits" 
account  to  the  exclusion  of  the  other  where  profits  are 
concerned. 

Adjustments  are  often  made  in  one  year  which  should 
have  been  made  in  prior  years  and  it  is  often  contended 
that  such  adjustments  should  be  given  effect  in  the  cur- 
rent year's  operations  and  not  through  the  Surplus  or 
Undivided  Profits  accounts,  as  we  have  recommended 
from  time  to  time.  The  arguments  advanced  in  favor  of 
such  action  is  that  if  the  item  is  not  given  effect  as 
against  the  current  year's  operations,  statements  of  opera- 
tions will  never  disclose  the  item. 

It  appears  to  us  that  simply  because  one  year's  records 
are  incorrect  there  is  no  logical  excuse  for  improperly 
stating  the  effect  of  the  efforts  of  some  other  year,  and 
that  the  adjustments  should  be  made  through  Undivided 
Profits  or  Surplus  account,  as  these  accounts  are  all  that 
remain  of  the  past  year's  results. 

By  having  all  such  items  specifically  stated  in  these 
accounts,  the  work  of  preparing  accurate  statements  of 
past  results  is  greatly  simplified. 

The  plan  the  writer  usually  takes  in  making  adjust- 
ments of  this  sort  is  to  make  them  through  an  account 
headed,  say,  "1904  Profit  and  Loss  Adjustment  Account," 
which  account,  in  turn  would  be  closed  into  the  Undi- 
vided Profits  account. 


160  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  In  a  case  where  the  preferred  shares  of  a  company 
are  issued  under  a  provision  that  the  annual  dividends 
to  which  they  shall  be  entitled  shall   be  "cumulative," 
would  you  consider  it  necessary  to  show  any  arrears  of 
dividend  as  a  Liability  upon  the  Balance  Sheet,  or  how 
would  you  deal  with  it?     (111.) 

2.  What  is  a  contingent  liability?     For  what  pur- 
pose and  in  what  form  should  such  liabilities  appear  in  a 
statement  of  financial  condition?     (Mass.) 

3.  Give  at  least  two  examples  of  contingent  liabili- 
ties and  state  how  they  should  be  treated  in  the  books. 
(Fla.) 

4.  A  corporation  authorizes  an  issue  of  11,000,000.00 
of  bonds.     The  trust  company  issues  and  certifies  $  500,- 
000.00  of  these  bonds  to  Dec.  31,  1907.    On  this  date  the 
company  sells  $200,000.00  of  bonds,  pledges  $200,000.00 
as  collateral  security  for  the  payment  of  its  notes  and 
has  $100,000.00  in  the  treasury.     How  should  this  issue 
of  bonds  appear  on  the  balance  sheet  of  the  corporation 
on  Dec.  31,  1907?     (N.  Y.) 

5.  Do  unsold  bonds  of  a  railroad  company  constitute 
a  liability?    If  they  do,  under  what  accounts  would  they 
appear  in  a  ledger?     Does  unsubscribed  stock  in  a  cor- 
poration constitute  a  liability?     If  it  does,  under  what 
accounts  would  it  appear  in  the  ledger?     (Mich.) 

6.  The  Bristol  Manufacturing  Company  issued  and 
sold  on  the  1st  of  January,  1911,  to  "A"  and  "B,"  100 
(50  to  each  at  the  same  price)  First  Mortgage  Bonds  of 


LIABILITIES  161 

$500.00  each,  bearing  interest  at  4%   per  annum,  and 
received  $48,000.00  in  cash. 

What  record  of  the  transaction  should  be  made?    (111.) 

7.  A  company  takes  a  large  number  of  notes  (Bills 
Receivable)  from  its  customers  and  when  in  need  of  funds, 
discounts  or  sells  them.     What  accounts,  if  any,  should 
appear  to  care  for  the  contingent  liability  thus  created? 

(N.  Y.) 

8.  Distinguish  between  the  accounts  usually  desig- 
nated "Surplus"  and  "Undivided  Profits"  as  to  (a)  defi- 
nition,  (b)   treatment. 

State  circumstances  under  which  it  is  proper  to  debit 
or  credit  "Surplus"  account.     (N.  Y.) 


CHAPTER  XVI 

Subsidiary  Accounts 

The  principal  use  to  which  subsidiary  accounts  are 
placed  is  to  contain  items  which  have  either  been  paid 
during  one  period  of  a  company's  operation  and  have  not 
been  used  or  which  have  accrued,  as  in  the  case  of  "Insur- 
ance paid  in  Advance"  or  "Bond  interest  accrued  but  not 
due,"  but  have  not  been  paid.  In  any  case,  at  the  time 
of  closing  the  books,  the  amount  transferred  from  the 
major  account  to  the  summary  account  (Profit  and  Loss 
or  Trading,  etc.)  must  represent  the  actual  effect  of  the 
year's  transactions  on  the  account  to  be  transferred.  If 
the  major  account  does  not  display  the  accurate  result 
the  account  must  be  adjusted  by  the  aid  of  a  subsidiary 
account  which,  often,  may  be  a  portion  of  the  major  ac- 
count and  remain  on  the  same  page  in  the  ledger,  but 
which,  for  the  purpose  of  closing  the  books,  is  subsidiary 
to  the  other  account. 

Insurance  Paid  in  Advance. 

To  illustrate:  The  insurance  account  of  a  certain 
firm  shows  a  balance,  Dr.,  of  $126.00.  Upon  checking  the 
account,  it  is  ascertained  that  the  amount  which  properly 
applies  to  the  current  year's  operations  only  amounts  to 
$106.00,  leaving  a  balance  of  $20.00  to  apply  against  the 
expense  of  the  succeeding  year.  In  adjusting  the  account, 
$20.00  is  carried  forward  as  Unexpired  Insurance  and  the 
$106.00  is  carried  to  the  Profit  and  Loss  Account,  this 
being  the  proper  expense  for  the  year.  Upon  opening 
the  books  for  the  new  year  the  $20.00  becomes  the  open- 


SUBSIDIARY  ACCOUNTS  163 

ing  balance  of  the  major  account  but,  for  the  purpose 
of  closing  the  books,  it  forms  a  subsidiary  account. 

Advertising  Appropriations. 

Occasionally  a  firm  may  inaugurate  an  extensive  cam- 
paign of  advertising  which  may  exhaust  the  usual  appro- 
priation of  a  number  of  years  and  from  which  profits  and 
additional  business  may  be  expected  to  accrue  for  a  con- 
siderable time.  In  this  case,  it  would  be  manifestly  unfair 
to  include  in  the  one  year  the  entire  expenditure  and,  in 
general,  a  portion  of  the  expenditure  becomes  a  deferred 
charge  to  the  operations  of  the  next  few  succeeding  years. 

In  the  case  of  a  very  extensive  campaign  covering  a 
number  of  years,  it  is  customary  to  appropriate  a  certain 
sum,  possibly  varying  with  each  year,  which  is  charged, 
as  expended,  to  ''Special  Advertising."  The  average 
expenditure  of  each  year,  during  the  life  of  the  campaign 
or  possibly  including  a  few  additional  years  where  the 
effect  would  be  felt  that  long,  would  be  transferred  from 
the  special  account  to  the  current  account  to  represent 
the  proper  portion  of  the  expenditure  chargeable  against 
the  current  year's  operations.  The  balance  of  the  Special 
Advertising  Account  would  remain  as  a  subsidiary  ac- 
count representing  the  deferred  charges  against  future 
years. 

Any  expenditure  in  excess  of  or  hot  included  in  the 
appropriation  would  be  charged  to  the  Advertising  Ac- 
count direct. 

Expenses  Incurred  in  Advance  of  Sales. 

Those  firms  that  supply  Christmas  Goods,  Fireworks, 
Clothing  and  similar  articles,  the  demand  for  which  is 
periodical,  often  incur  a  considerable  amount  of  expense 
during  one  fiscal  year  which  properly  belongs  to  the  next 


164  ACCOUNTING  PRINCIPLES 

period,  it  being  directly  applicable  to  the  succeeding 
year's  sales.  There  is,  of  course,  an  argument  that  each 
year's  expenditures  will  equalize  themselves,  but  this 
hardly  seems  proper,  for  one  year's  expense  may  be  all 
out  of  proportion  with  the  business  done,  say,  in  the  early 
part  of  the  year,  and  the  financial  statements  will  be 
inaccurate  to  that  extent;  therefore,  it  seems  more  desir- 
able that  all  expenses  incurred  after  the  periodical  busi- 
ness has  ceased  should  be  carried  forward  into  the  next 
year's  business  or,  preferably,  if  it  is  possible  to  do  so, 
the  fiscal  year  should  be  changed  so  that  it  will  expire 
at  a  proper  moment  to  include  all  transactions  leading 
up  to  and  including  a  selling  period. 

Discount  on  Bonds. 

Discount  on  Bonds  sold  is  a  prepaid  expense,  appor- 
tionable  over  the  life  of  the  bonds  like  the  interest,  and 
should  be  treated  accordingly  by  retaining  on  the  books 
from  year  to  year  such  portion  of  the  original  discount 
as  properly  applies  to  future  years. 

In  practice,  it  is  frequently  considered  inadvisable  to 
carry  this  item  over  a  great  many  years,  as  would  be 
necessary  where  the  life  of  the  bond  is  very  great,  and 
the  account  is  closed  on  the  books  by  charging  it  against 
Net  Profits.  Discount  on  Bonds  sold  cannot,  properly,  be 
considered  as  a  charge  against  operations.  It  is,  rather, 
an  expense  incidental  to  a  deficiency  of  capital,  there- 
fore any  statements  that  may  be  prepared,  setting  forth 
the  result  of  operations,  would  not  be  affected  even  though 
the  entire  discount  were  closed  out  and,  if  profits  were 
available  with  which  to  wipe  out  the  account,  no  serious 
objection  could  be  raised  to  this  procedure.  (See  Secret 
Reserves. ) 

Expense  incurred  in  negotiating  an  issue  of  bonds  is 
usually  capitalized,  as  the  bond  proceeds  are  usually  used 


SUBSIDIARY  ACCOUNTS  165 

for  acquiring  Capital  Assets.  If,  however,  the  bond  pro- 
ceeds are  to  be  used  for  Working  Capital  and  a  consid- 
erable sum  is  involved,  the  expenses  incurred  in  financing 
the  issue  could  properly  be  spread  over  the  life  of  the 
bond  the  same  as  the  Discount. 

Suspense  Accounts. 

During  the  course  of  adjusting  or  closing  the  books 
or  even  during  a  period  of  operations,  items  arise  which 
for  some  reason  or  other,  cannot  be  analyzed  sufficiently 
to  properly  place  them  on  the  books.  It  then  becomes 
necessary  to  make  such  entry  as  is  possible ;  throwing  the 
unapportionable  balance  into  a  suspense  account,  prop- 
erly headed,  for  future  attention. 

The  following  were  used  recently,  when  adjusting  the 
books  of  a  branch  office,  and  are  good  examples  of  this 
style  of  an  account : 

"Spokane  Bills  Keceivable  Suspense  Account" 

Used  where  a  reconciliation  of  the  account  was 
impossible  and  where  records  were  not  available  to 
check  out  the  entire  account,  but  where  it  was  neces- 
sary to  give  effect  to  the  account  on  the  books. 

"Executive  Office  Collection  Suspense  Account" 

Opened  for  a  similar  purpose,  covering  collections 
made  by  the  branch  for  the  home  office  and  errone- 
ously reported  to  them. 

Such  accounts  should  be  closed  at  the  earliest  possible 
moment  and  not  allowed  to  stand  in  anticipation  that 
they  will  automatically  close  themselves. 

Accrued  Expenses. 

There  are  a  considerable  number  of  items,  such  as 
taxes,  rent,  interest,  wages,  etc.,  which  accrue  with  the 


166  ACCOUNTING  PRINCIPLES 

effluxion  of  time,  viz.,  each  moment  of  time  causes  an  in- 
crease in  the  amount  properly  chargeable  to  these  ac- 
counts and,  owing  to  the  fact  that  the  increase  is  con- 
tinuous, it  becomes  impossible  to  record  it  as  it  accrues. 
The  usual  procedure  is  to  pay  them  as  they  become  due, 
charging  the  amount  paid  to  the  respective  accounts  and 
then,  whenever  it  becomes  necessary  to  close  the  books 
and  determine  the  profits  for  a  period  or  the  status  of  a 
concern  as  at  the  end  of  a  period,  the  amount  that  has 
accrued  during  the  year  is  transferred  to  Revenue,  irre- 
spective of  what  the  account  balance  shows.  The  amount 
remaining  forms  a  subsidiary  account  for  Balance  Sheet 
purposes  and  would  appear  therein  under  an  appropriate 
heading,  such  as  Taxes  Accrued  and  Unpaid,  etc. 

The  subsidiary  account  may  form  the  nucleus  of  the 
major  account  upon  opening  the  books  for  the  new 
period. 

Premium  on  Bonds. 

The  premium  on  an  issue  of  bonds  sold,  like  the  dis- 
count, should  be  set  aside  to  adjust  future  interest  pay- 
ments. 

In  connection  with  the  issue  of  bonds,  attention  is  di- 
rected to  the  manner  of  paying  interest  on  each  bond. 

In  general,  interest  is  payable  semi-annually  and  if  a 
bond  is  disposed  of  at  any  time  between  the  interest 
dates,  it  carries  with  it,  the  interest  that  has  accrued 
since  the  last  interest  date;  therefore,  if  a  bond  were  sold 
at  a  premium  or  a  discount  at  any  time  between  the  two 
interest  dates  and  if  no  provision  was  made  at  the  time 
of  sale  for  the  interest  that  had  accrued,  consideration 
would  have  to  be  given  the  accrued  interest  in  determin- 
ing the  actual  premium  or  discount.  The  amount  of  in- 
terest that  was  sold  with  the  bond  should  be  credited  to 


SUBSIDIARY  ACCOUNTS  167 

Bond  Interest  Account  to  offset  a  portion  of  the  amount 
that  would  be  paid  on  the  next  interest  date. 

Premium  on  Stock. 

In  the  organization  of  double  liability  corporations 
such  as  banks,  etc.,  and  also  in  the  case  of  industrial  con- 
cerns where  the  stock  has  been  increased,  it  is  not  unusual 
to  have  the  stock  issued  at  a  premium.  • 

In  either  case,  there  is  no  legal  objection  to  crediting 
the  premium  to  Undivided  Profits  Account  and  repaying 
it  to  the  stockholders  as  a  dividend  except  in  cases  where 
a  certain  surplus  is  required  by  law  in  addition  to  the 
Capital  Stock.  In  general,  however,  the  premium  is 
credited  to  a  "Premium  on  Capital  Stock"  account  which 
is  intended  to  remain  on  the  books  as  a  surplus  not  avail- 
able for  dividends. 

In  the  case  of  the  new  organization,  the  reasons  for 
issuing  the  stock  at  a  premium  are  usually  to  provide 
the  Surplus  required  or  to  secure  desired  Working  Capi- 
tal with  a  minimum  of  Capital  Stock.  The  object  of  so 
doing  being  to  limit  as  much  as  possible  the  liability 
existing  under  the  double  liability  clause  of  the  various 
special  incorporation  laws. 

Where  a  concern  has  increased  its  Capital  Stock  and 
has  issued  the  new  stock  at  a  premium,  the  company  does 
not  directly  profit  by  the  transaction,  for  any  premium 
received  would  still  be  the  property  of  the  stockholders; 
the  company  simply  having  the  use  of  it  during  the  period 
it  remains  in  their  hands. 

The  objects  to  be  secured  by  the  issue  of  stock  in  this 
manner  are  to  equalize  the  value  of  the  old  stock  and  the 
selling  price  of  the  new  and  to  provide  the  desired  work- 
ing capital  with  as  small  an  increase  of  the  dividend  bear- 
ing stock  as  possible,  thereby  enabling  the  company  to- 


168  ACCOUNTING  PRINCIPLES 

pay  a  satisfactory  rate  of  dividend  on  the  stock  outstand- 
ing with  a  lesser  sum  than  would  be  required  were  a 
greater  amount  of  stock  distributed. 

If  the  new  stock  were  issued  as  outlined  above,  the 
new  stockholders  would  receive,  at  some  date,  more  or 
less  removed,  pro  rata  with  the  old,  a  portion  of  the 
premium  that  they  had  paid  into  the  company  and,  to 
avoid  this,  it  is  customary  to  grant  to  the  old  stockholders, 
proportionate  to  their  holdings,  the  right  to  subscribe  for 
the  new  stock  at  par.  This  right  is  transferable  and,  if 
the  stockholder  does  not  care  to  use  it  himself,  he  may 
sell  it  to  some  other  party  who  pays  him  the  value  of  the 
premium  and  the  company  the  par  value  of  the  stock. 

In  general,  the  holders  of  an  original  issue  of  stock, 
provided  it  is  not  to  be  exchanged  for  property,  have  a 
prior  right  to  subscribe  for  any  new  stock  and  they  can- 
not be  called  upon  to  pay  more  than  par  therefor. 

Premium  on  the  sale  of  Treasury  Stock  is  usually 
closed  into  "Undivided  Profits"  direct,  but  Discount  on 
Treasury  Stock  is  generally  considered  as  an  offset  to 
"Donations"  or  whichever  account  received  credit  at  the 
time  the  Treasury  Stock  was  placed  on  the  books. 


SUBSIDIARY  ACCOUNTS  169 


C.  P.  A.  Questions 

1.  Would  you  consider  it  proper  to  include  as  an 
asset  the  following  items :  Insurance  premium  unearned, 
taxes  paid  in  advance,  advertising  expense?  Explain 
briefly  and  give  reasons.  (N.  Y.) 

'2.  A  firm  expends  considerable  sums  upon  advertise- 
ments in  order  to  form  a  business.  Assuming  that  the 
expenditure  thereon  decreases  annually  until,  in  the  sev- 
enth year,  it  reaches  a  point  representing  a  normal  annual 
cost  under  this  head,  how  would  you  expect  the  amounts 
to  be  treated  in  the  books?  In  your  reply  let  $14,000.00 
be  the  expenditure  of  the  first  year  and  decrease  $2,000.00 
annually.  (Adapted  from  I).  A.  A.) 

.">.  A  railway  company  sells  on  Oct.  1,  1900,  an  issue 
of  5%  20  year  bonds  dated  Sept.  1,  1900,  at  110  flat.  How 
should  the  premium  received  be  treated  on  the  books  of 
the  company?  (N.  Y.) 

4.  Explain  what  is  meant  by  suspense,  prepaid  and 
accrued  accounts,  and  give  examples  of  each,  showing 
proper  classification  as  to  debits  and  credits.     (Adapted 
from  Mich.) 

5.  From  the  standpoint  of  a  corporation  which  re- 
quires additional  capital,  would  it  be  preferable  to  issue 
the  new  stock  at  par  pro  rata  to  the  old  stockholders  or 
should  it  be  sold  in  the  open  market  at  the  highest  price 
obtainable.     (XXX.) 

6.  What  portion   of  $15,000 — commission    paid    for 
negotiating  a  sale  of  bonds  to  run  10  years — should  be 
treated  as  an  asset  at  the  end  of  the  first  year?     Give 
reasons.     (N.  Y.) 


170  ACCOUNTING  PRINCIPLES 

7.  A  company  receives  a  premium  on  its  own  capital 
stock.     What  account  should  receive  credit  for  the  pre- 
mium?    Is  this  premium  available  for  the  payment  of 
dividends?    Give  reasons  to  sustain  your  answer.     (N.  Y.) 

8.  How   should   the   discount  and   premium   arising 
from  the  sale  of  a  company's  own  securities  held  in  its 
treasury  be  treated  on  the  books?  Give  examples.    (N.  Y.) 

9.  Outline  an  entry  recording  bond  interest  due  but 
not  paid  at  time  of  making  the  entry.    What  are  the  ad- 
vantages of  such  an  entry?     (N.  Y.) 

10.  Mention  other  items  which  could  be  treated  in  a 
similar  way  to  that  suggested  for  interest  in  the  previous 
question   and   state   the   advantages   of   such   treatment. 

(N.  Y.) 

11.  Illustrate    in    the    form    of   journal    entries    the 
accrual  of  discount  and  the  amortization  of  the  premium 
on  bond  investments.     Explain  or  illustrate  the  relation 
of  each  to  the  interest  receipts  and  to  the  income  returns. 

(N.  y.) 


CHAPTER  XVII 

Reserves 

In  taking  up  the  discussion  of  Reserves,  we  must  ad- 
mit that,  considering  the  object  of  this  work  in  connection 
with  outlining  the  principles  of  accounting  with  a  view 
of  assisting  the  student  in  satisfying  the  various  State 
Boards  of  Accountancy,  we  are  entering  it  with  some 
hesitancy  due  to  the  great  divergence  of  opinion  that 
exist  not  only  amongst  the  authorities  on  accounting  but 
the  examiners  as  well ;  and  no  matter  what  views  may  be 
mentioned  we  assuredly  would  differ  from  the  majority 
of  those  who  have  expressed  themselves  on  the  subject 
and  also  those  who  have  the  future  of  the  student  in  their 
hands  as  members  of  the  various  examining  boards.  It 
behooves  us,  then  to  follow  out  the  principles  as  they 
appeal  to  us  irrespective  of  what  may  have  been  written 
in  the  past,  in  the  hopes  that  through  this  work,  some  of 
the  uncertainty  of  the  subject  will  be  eliminated  and  the 
student  will  feel  more  confident  that  his  views  do  not 
conflict  with  those  of  his  judges  when  he  enters  the  exami- 
nation room. 

The  principal  trouble  seems  to  lie  in  the  failure  to 
distinguish  between  the  source  of  the  various  items  which 
go  to  make  up  the  Reserves.  Some  of  them  represent 
charges  to  the  Revenue  Account  while  others  are  created 
by  charging  Undivided  Profits  or  Surplus. 

Those  that  originate  in  the  Revenue  Account  invari- 
ably represent  the  estimate  of  loss  or  expense  that  has 
occurred,  as  distinguished  from  the  actual  expenditure 
that  has  been  made  to  replace  that  loss,  or  loss  that  has 
required  attention  during  the  year.  To  illustrate:  In  a 


172  ACCOUNTING  PRINCIPLES 

given  year  the  manager  of  a  concern  estimates  that  the 
proportion  of  loss  through  bad  debts  which  is  properly 
chargeable  to  that  year,  will  be  $500.00.  Possibly  an 
analysis  of  the  ledger  will  not  disclose  bad  accounts  rep- 
resenting anywhere  near  that  sum  and  but  few  more 
that  are  doubtful,  but  experience  has  taught  that,  in  con- 
ducting any  business,  losses  through  undesirable  credit 
will  surely  result  and,  in  correctly  stating  the  account  for 
any  period,  it  becomes  necessary  to  reserve  a  portion  of 
the  Revenue  of  that  year  to  provide  for  the  proportion 
of  the  sales  that  are  to  undesirable  customers.  The 
reserve  provided  is  supposed  to  cover  all  losses  that 
occur  even  though  at  the  time  the  reserve  was  made  ac- 
counts were  thought  to  be  good  which  later  proved  to 
be  bad  and,  as  losses  occur,  they  are  charged  against 
the  reserve  instead  of  against  revenue  to  which  they  would 
have  to  be  charged  had  no  provision  been  made  in  pre- 
vious years  to  care  for  them. 

Those  charges  that  originate  in  the  Undivided  Profits 
Account  represent  profits  that  have  been  set  aside  for 
some  purpose;  possibly  to  retain  in  the  business,  a  sum 
with  which  to  make  extensions,  which,  without  the  Re- 
serve would  require  a  new  issue  of  stock  or  an  issue  of 
bonds.  The  fact  that  these  profits  have  been  ear-marked 
and  separated  from  the  others  does  not  affect  their  avail- 
ability for  any  other  purpose  that  may  arise  and  which 
may  appear  to  be  more  important  than  the  one  for  which 
the  account  was  originally  opened ;  provided,  of  course, 
that  there  is  no  existing  obligation  covering  the  operation 
of  the  account. 

The  former  is  known  as  a  Reserve  Account  and  the 
latter  as  a  Reserve  Fund.  The  first  represents  the  esti- 
mated loss  incurred  through  some  channel  and  is  intended 
to  be  closed  out  as  soon  as  the  actual  expenditure  is  de- 


RESERVES  173 

termined.     The  other  represents  profits,  changed  in  pur- 
pose but  not  in  form. 

To  summarize:  A  Reserve  Account  represents  the 
provision  made  for  a  known  but  inestimable  loss  that 
has  occurred  and  is  to  be  provided  for  out  of  revenue 
awaiting  the  final  ascertainment  of  the  loss.  A  Reserve 
Fund  represents  profits  that  have  been  set  aside  to 
provide  for  some  expenditure  the  requirement  of  which 
may  be  either  certain  or  a  contingency. 

Excessive  losses,  greater  than  the  amount  of  Undivided 
Profits,  must  act  as  a  reduction  of  the  Reserve  Fund  but 
they  would  have  no  effect  on  the  Reserve  Account  for  it 
already  represents  similar  items,  the  effect  of  which  has 
been  provided  for. 

In  the  preparation  of  Balance  Sheets  or  other  reports 
covering  the  status  of  the  accounts,  the  Reserve  Account 
becomes  an  offset  to  its  Major  Account,  if  the  Major  Ac 
count  appears  in  the  books,  and  is  sho\vn  in  the  report  as 
a  deduction  from  it;  the  Reserve  Fund  is  invariably  an 
adjunct  to  Surplus  Account  and  should  appear  as  such. 

Reserve  Accounts. 

Reserve  accounts  may  be  provided  for  almost  any 
purpose;  the  principal  ones  are  in  connection  \vith  the 
loss  through  bad  debts,  depreciation  and  deterioration 
of  stock. 

The  advantages  derived  by  providing  them  are  that 
losses  may  be  provided  for  on  a  number  of  objects  as  a 
group  without  affecting  the  individual  items  of  the  group 
or  the  total  thereof,  and  that  the  cost  of  articles  may  re- 
main on  the  books  for  use  in  the  adjustment  of  fire  losses, 
etc. 

Before  going  further  in  their  discussion,  we  wish  to 
make  clear  the  manner  of  placing  the  items  on  the  books. 


174  ACCOUNTING  PRINCIPLES 

As  an  example,  let  us  refer  to  the  illustration  just 
used  relative  to  the  loss  incurred  in  a  certain  firm  through 
bad  debts.  From  past  experience  they  have  ascertained 
that  the  probable  loss  in  this  particular  year  will  be 
approximately  f 500.00 ;  they  wish  to  give  this  effect  with- 
out interfering  with  the  accounts  and  make  the  entry : 

Profit  &  Loss  (Trading) $500.00 

Reserve  for  Bad  Debts 1500.00 

To  provide  for  possible  loss  through  bad  debts. 

In  a  short  time  it  is  decided  that  a  certain  account  is 
hopeless  and  should  be  eliminated  from  the  ledger;  the 
entry 

Reserve  for  Bad  Debts $100.00 

John   Doe   $100.00 

To  close  the  latter  account. 

is  then  made,  closing  out  the  John  Doe  account  and  re- 
ducing the  reserve.  Should  the  reserve  account  become 
entirely  wiped  out  through  losses  that  were  not  antici- 
pated, the  excess  of  losses  should  be  closed  into  Profit 
and  Loss,  and  not  charged  to  the  reserve. 

Reserve  for  Bad  Debts. 

In  estimating  the  amount  that  should  be  provided 
to  cover  the  loss  through  bad  debts,  it  is  customary  to 
build  up  the  reserve  so  that  it  is  equal  to  approximately 
2%  of  the  accounts  outstanding  as  displayed  by  the 
books.  This  plan  is  fallacious  in  that,  if  a  considerable 
number  of  accounts  are  closed  out  during  any  one  year, 
it  may  entirely  wipe  out  the  Reserve  Account,  with  the 
result  that  that  year  will  have  to  provide  for  its  entire 
rebuilding;  whereas,  if  but  few  accounts  are  closed  out, 
but  a  small  additional  amount  will  be  required  to  bring 


RESERVES  175 

(lie  account  back  to  its  required  amount.  In  practice  it 
virtually  amounts  to  charging  the  losses  as  they  are  deter- 
mined direct  to  Profit  and  Loss  and  then  adjusting  the 
Reserve  Account,  at  the  end  of  each  period,  proportionate 
to  the  amount  of  accounts  outstanding  at  that  time. 

Where  this  plan  is  used,  often  a  loss  is  not  anticipated 
on  the  Bills  Receivable  Account.  Losses  undoubtedly  re- 
sult through  the  non-payment  of  notes  and  such  losses 
should  be  provided  for. 

Frequently  the  accounts  are  not  analyzed  to  determine 
if  Ilie  reserve  is  sufficient  to  cover,  as  it  should,  not  only 
those  debts  that  are  known  to  be  bad,  but  also  a  suffi- 
cient proportion  of  those  supposed  to  be  good;  the  ten- 
dency being  to  let  the  2%  suffice,  thereby  misrepresenting 
the  accounts. 

The  more  desirable  plan  seems  to  be  to  set  aside  at 
desirable  intervals  a  proportion,  say  \%  or  less  of  the 
sales  that  have  occurred  during  the  period  under  review. 
This  has  the  decided  advantage  of  placing  the  loss  where 
it  belongs — as  a  charge  against  the  sales — and  of  spread- 
ing the  loss  proportionately  over  each  period  and  upon 
every  article  sold.  The  loss  actually  occurred  at  the  time 
of  sale  and  should  be  entered  during  that  period.  If  a 
note  should  eventually  be  taken  its  probable  loss  would 
have  already  been  cared  for  and  would  require  no  addi- 
tional attention. 

If  at  some  future  date,  it  is  found  that  the  rate  used 
is  incorrect  the  Reserve  Account  could  be  adjusted  through 
the  Undivided  Profits  or  Surplus  Account  and  the  rate 
could  be  corrected  for  future  use. 

Reserve  for  Cash  Discount. 

Cash  Discount,  we  believe,  relates  to  the  period  in 
which  it  is  granted  or  taken,  hence  no  provision  need  be 


176  ACCOUNTING  PRINCIPLES 

made  in  one  year  to  protect  it  against  the  succeeding 
year. 

If  a  discount  is  allowed  in  one  year,  that  year  has  the 
use  of  the  money  and  should  stand  the  discount. 

Reserve  for  Depreciation* 

In  connection  with  either  the  plan  of  writing  off  a 
proportion  of  the  original  purchase  price  of  an  article 
or  that  of  writing  off  a  certain  percentage  of  its  original 
cost,  it  is  desirable  to  set  aside  in  a  Reserve  Account  the 
amount  that  has  been  determined  upon  as  the  proper 
depreciation,  so  that  the  Asset  Account  will  continue  to 
show  the  actual  cost  of  the  articles  purchased.  In  the 
former  case  it  is  particularly  desirable  that  the  original 
purchase  price  remain  on  the  books  and  in  the  latter  the 
book  value  can  easily  be  ascertained  by  deducting  the 
amount  of  the  subsidiary  account  from  that  of  the  major 
account. 

The  amount  that  has  been  provided  should  be  charged 
with  all  expenditures,  which  it  is  intended  to  cover,  as 
they  occur.  It  should  not  be  charged  with  any  items, 
provision  for  which  has  not  been  made  and  included  in 
the  account.  Repairs  caused  by  accident,  assuredly 
should  not  be  included  in  the  account;  they  should  be 
charged  direct  to  an  expense  account  of  some  sort. 
Neither  should  Replacements,  for  they  are,  in  effect,  the 
purchase  of  new  articles,  and  should  be  charged  direct 
to  the  Asset  Account.  The  article  which  they  replace 
should  be  deducted  from  the  Asset  Account  and  the  Re- 
serve Account  should  be  reduced  by  the  amount  of  depre- 
ciation it  contains,  which  refers  to  that  particular  asset. 
Should  the  amount  not  be  sufficient  to  cover  the  depre- 
ciation that  has  now  been  ascertained,  the  balance  should 
be  written  off  out  of  Undivided  Profits  Account. 

It  will  be  noticed,  here,  that  as  we  have  outlined  a 


RESERVES  177 

Reserve  for  Depreciation,  it  is  intended  to  include  certain 
sums  for  each  particular  class  of  anticipated  loss.  I'n 
doubtedly  it  would  be  easier  to  consider  the  reserve  as  a 
provision  for  whatever  may  occur,  irrespective  of  the 
amount  that  has  been  provided  for  certain  contingencies, 
but,  so  long  as  the  reserve  is  but  an  estimate  and  also  as 
it  includes  various  estimates  on  particular  objects  and 
covering  particular  losses,  would  it  not  be  better,  if  it  is 
possible  to  do  so,  to  adjust  each  loss  as  it  is  ascertained 
with  the  provision  that  has  been  made  for  that  loss? 
As  an  example:  Let  us  take  the  case  of  a  machine  cost- 
ing $1,000.00  and  depreciated  at  the  rate  of  10%  on  re- 
ducing balances.  In  five  years  the  book  value  of  that 
particular  machine  will  be  $590.50.  Let  us  presume  that 
it  becomes  necessary  to  dispose  of  it  and  to  replace  it 
with  a  new  and  better  article  and  that  the  amount  ob- 
tained from  it  is  but  $300.00.  To  adjust  the  accounts,  we 
si  101  ihl  reduce  the  asset  account  by  the  amount  of  its 
purchase  price,  $1,000.00.  We  would  then,  under  one 
plan— the  incorrect  one — charge  the  Reserve  Account  with 
the  loss  $700.00  or,  under  the  other  plan,  with  the  amount 
it  contains  that  represents  the  anticipated  depreciation, 
viz.,  $400.50.  The  balance  of  $200.50  represents,  undoubt- 
edly a  loss  that  has  not  been  provided  for  and  this  loss, 
now  that  it  has  been  ascertained,  should  be  charged 
direct  to  Undivided  Profits  Account  as  effecting  previous 
years. 

In  the  former  case,  the  Reserve  Account  would  be 
rharm'd  with  a  loss  which  it  had  not  been  provided  for 
and,  hence,  owing  to  the  reduction,  it  would  not  be  suffi- 
cient provision  for  the  anticipated  loss  on  other  articles. 

The  loss  that  has  been  provided  for,  in  connection 
with  any  particular  article,  can  be  easily  determined,  its 
cost  and  the  rate  of  depreciation  being  known ;  so  what 


178  ACCOUNTING  PRINCIPLES 

excuse  is  there  for  not  correctly  stating  the  loss  in  the 
books  after  it  has  been  determined? 

During  the  first  few  years  of  an  article's  use,  the 
amount  expended  to  renew  worn  parts  will  be  necessarily 
small  but  the  wear  that  has  been  applied  during  this 
period  is  proportionately  liable  for  the  eventual  expendi- 
ture and  the  year  should  be  charged  with  its  proportion. 
An  estimate  of  the  probable  wear  should  be  made  and 
should  be  charged  against  the  current  year's  operation 
and  credited  either  to  the  Reserve  for  Depreciation  Ac- 
count or,  if  desired,  to  an  account  headed  "Reserve  for 
Renewals,"  then  as  renewals  are  made  the  Reserve  for 
Renewals  could  be  charged  with  the  expenditure. 

The  advantage  of  separating  the  items  into  Reserve 
for  Renewals  and  Reserve  for  Depreciation  lies  in  that  the 
different  elements  of  depreciation  are  separated  and 
neither  of  the  reserves  could  become  exhausted  at  the 
expense  of  the  other  without  the  fact  being  known. 

Losses  on  small  tools,  as  ascertained,  are  usually 
charged  directly  against  operations,  during  the  period 
that  the  loss  is  determined;  therefore  no  provision  need 
be  made  in  the  nature  of  a  reserve  for  this  class  of  loss. 

Reserve  for  Fire  Loss. 

A  great  number  of  firms,  owing  to  the  scope  of  their 
business  and  the  fact  that  it  is  widely  scattered,  are 
able  to  assume  the  risk  of  loss  through  fire,  except,  pos- 
sibly in  their  factory  or  some  of  their  most  important 
branches,  and,  instead  of  paying  out  considerable  sums 
annually  for  insurance,  they  insure  the  property  them- 
selves by  charging  Profit  and  Loss,  possibly  through  each 
branch,  with  such  a  sum  as  would  have  been  paid  out  in 
premiums  had  the  property  been  insured  by  outsiders, 
and  crediting  this  amount  to  an  account  headed  "Re- 


RESERVES  179 

serve  for  Fire  Losses."  As  losses  occur  they  are  written 
off  against  the  reserve.  Should  the  reserve  prove  insuffi- 
cient the  additional  losses  must  be  cared  for  out  of  profits. 
Under  no  condition  should  they  be  allowed  to  remain  on 
the  books  in  the  hopes  that  future  reserves  will  be 
sufficient  to  wipe  out  the  old  loss  and  also  to  provide  for 
such  additional  losses  as  occur. 

If  the  condition  of  the  business  is  such  that  it  could 
possibly  be  crippled  by  a  loss,  it  is  undoubtedly  better  to 
place  the  insurance  outside  of  the  business;  if,  however,  it 
'  is  decided  to  carry  the  insurance  in  the  business,  a  sum 
should  be  invested  outside  of  the  business,  in  some  form 
that  would  allow  immediate  realization  to  equal  the 
amount  of  the  Eeserve.  If  a  loss  occurs  the  securities 
cor  Id  be  converted  into  Cash,  thereby  allowing  the  imme- 
diate replacement  of  the  loss.  Any  loss  that  occurs  could, 
a  Her  it  has  been  ascertained,  be  charged  against  the 
reserve. 

If,  after  operating  a  considerable  number  of  years,  it 
is  found  that  the  Reserve  is  out  of  proportion  with  the 
amount  of  loss  that  could  reasonably  be  expected  through 
fire,  the  Reserve  may  be  written  down  slightly  and  a 
profit  assumed  through  the  operation  of  the  account.  This 
profit,  would,  however,  be  a  direct  credit  to  Undivided 
Profits  Account  and  should  not  disturb  the  statements 
showing  the  current  operation  of  the  business,  neither 
should  the  annual  charge  for  insurance  be  interfered  with 
so  long  as  it  represents,  approximately,  the  amount  that 
would  have  to  be  paid  out  as  insurance  premiums. 

Reserve  for  Deterioration  of  Stock. 

The  custom  of  inventorying  old  or  not  readily  saleable 
stock  at  some  arbitrary  figure  is  to  be  regretted,  for,  no 
matter  how  conservative  the  appraiser  might  be,  the 
appraisal  from  year  to  year  will  assuredly  vary  and 


180  ACCOUNTING  PRINCIPLES 

will  have  a  considerable  effect  on  the  amount  of  profit 
ascertained.  Possibly  in  one  year,  the  goods  may  be  con- 
sidered worthless  and  be  omitted  from  the  inventory  and 
in  the  next  year,  due  possibly  to  a  lack  of  knowledge  on 
the  part  of  the  party  making  the  inventory,  they  may 
appear  at  full  value  or  nearly  so,  with  the  result  that  the 
porportion  of  profit  to  turnover  will  be  disturbed,  pro- 
portionate to  the  amount  involved. 

The  better  plan  seems  to  be,  as  outlined  in  Chapter 
VIII,  to  inventory  the  goods  at  cost  as  long  as  they  are 
included  in  the  regular  stock  and  to  set  up  a  reserve  to 
cover  their  decrease  in  value  by  charging  Revenue  and 
crediting  Reserve  for  Deterioration  of  Stock.  The  Reserve 
Account  to  be  adjusted  from  year  to  year  in  accordance 
with  the  possible  loss  anticipated. 

Should  any  of  the  goods  be  sold  at  a  reduced  price, 
the  Inventory  Account  should  receive  credit  for  the  cost 
price  and  the  difference  between  that  and  the  realized 
price  should  be  charged  to  the  Reserve;  but  should  the 
goods  be  sold  at  a  sum  in  excess  of  the  cost  price  but  still 
with  an  allowance  for  deterioration,  the  Sales  Account 
should  not  be  disturbed  by  the  sale,  for  it  does  not  carry 
the  proper  proportion  of  profit ;  instead  the  excess  of  sell- 
ing price  over  cost  should  be  credited  to  "Profit  on  the 
sale  of  Deteriorated  Stock"  and  the  balance  credited  to 
the  Inventory  Account. 

Reserve  for  Damages  to  Leased  Property. 

In  connection  with  leases,  there  is  often  provision 
made  covering  the  replacing  of  property  in  its  original 
condition  and  some  provision  must  be  made  during  the 
life  of  the  lease  to  provide  for  this  loss. 

An  amount  should  be  set  aside  from  Revenue  during 
each  year  of  the  life  of  the  lease,  if  the  damages  may 


RESERVES  181 

be  presumed  to  accrue  during  the  entire  period,  or  during 
the  last  few  years  if  their  nature  is  such  that  this  pro- 
cedure appears  proper.  If  no  provision  is  made  during 
the  early  years  of  the  lease  and  if  the  damages  may  be 
traced  to  that  period,  Surplus  should  be  charged  with 
the  amount  apportionable  to  those  years. 

Reserve  Funds. 

In  connection  with  Reserves  the  use  of  the  word 
"Fund"  is  often  criticised  on  the  assumption  that  a  Fund 
must  be  Cash  and  an  asset,  whereas  it  is  used  as  a  credit 
representing  an  assumed  liability.  The  same  argument 
might  equally  well  be  applied  to  the  word  "Reserves"  in 
that  a  reserve  must  be  something  substantial  and  in  pos- 
session, in  which  case  it  must  be  an  asset,  but  we  doubt 
if  this  objection  has  ever  been  raised.  The  distinction 
bet  \veen  the  two  is  not  sufficient  to  warrant  that  the  en- 
tire discussion  should  revert  to  the  one  word  to  the  ex- 
clusion of  the  other. 

Immediately  that  it  is  desired  to  establish  a  trust  in 
connection  with  some  particular  undertaking  and  that 
trust  is  established,  it  becomes  necessary  to  give  effect  to 
that  trust.  This  can  only  be  accomplished  by  giving  the 
trust  credit  for  such  sum  as  is  believed  proper  and,  pro- 
vided that  the  trusl  is  our  trust  and  the  amount  it  con- 
tains is  to  be  held  in  reserve,  we  must  call  it  a  "Reserve ;" 
also,  as  it  represents  resources  to  the  credit  of  that  Re- 
serve we  may  call  it  a  "Fund"  for  a  fund  need  not  neces- 
sarily he  cash.  It  may  be  of  wisdom  or  of  good  sense  or 
anything  else  of  value. 

The  fact  that  the  amount  designated  is  a  credit  balance 
is  no  objection  to  the  use  of  the  term  "Fund,"  neither 
does  its  use  in  connection  with  a  credit  balance  restrict 
its  use  to  that  side  only.  It  applies  equally  well  to  things 
in  possession  and  may  appear  as  an  asset. 


182  ACCOUNTING  PRINCIPLES 

A  Reserve  Fund  may  be  created  for  almost  any  pur- 
pose for  which  the  profits  that  would  have  been  distrib- 
uted as  dividends  could  be  used.  Its  principal  value  lies 
in  reserving  in  the  business  sums  with  which  to  build 
up  and  strengthen  it,  to  pay  off  existing  obligations,  or  to 
equalize  dividends.  If  the  reserve  is  to  be  of  a  permanent 
nature — say  to  provide  permanent  Working  Capital,  it 
should  be  specially  headed  so  that  it  will  never  be  looked 
upon  as  available  for  dividends. 

It  is  also  used  in  connection  with  profits  arising 
through  exceptional  sources  as  from  the  sale  of  stock  at  a 
premium  or  the  sale  of  real  estate.  In  general,  such 
profits  are  set  aside  in  reserve  for  exceptional  losses  in- 
stead of  being  declared  as  a  dividend.  There  is,  of  course, 
no  objection  to  using  such  a  reserve,  or  for  that  matter, 
any  Reserve  Fund  that  is  not  affected  by  existing  obliga- 
tions, for  any  other  purpose  that  may  appear  desirable. 

The  entry  required  to  set  a  reserve  fund  on  the  books 
comprises  a  charge  to  Undivided  Profits  Account  and  a 
credit  to  some  account  designating  the  purpose  of  the 
fund,  say,  "Reserve  Fund  to  Provide  for  Extensions,"  or 
"Reserve  Fund  for  Contingencies,"  or  where  a  Reserve 
Fund  is  being  set  up  on  the  books  to  represent  an  antici- 
pated profit  the  actual  attainment  of  which  is  in  the 
future,  as  in  the  case  where  a  fixed  asset  has  appreciated 
but  where  its  sale  has  not  been  consummated,  the  entry 
would  be 

Property  or  Fixed  Assets  X 

Special  Reserve  Fund  created  by  appre- 
ciation of  Fixed  Assets,  not  available 
for  dividends  X 

To  give  effect  to  a  known  appreciation 
in  property. 

The  use  of  the  term  "Fund"  is  often  omitted,  even  in 
connection  with  items  which  undoubtedly  arise  from 


RESERVES  183 

profits.  But  where  the  importance  of  discriminating  be- 
tween the  two  classes  of  items  is  so  great,  it  appears  that 
considerable  stress  should  be  laid  upon  the  character  of 
each  reserve  and  this  can  be  best  accomplished  by  label- 
ing them  in  every  case. 

Secret  Reserves. 

A  Secret  or  Hidden  Reserve  represents  an  accumu- 
lation of  profits  which  is  not  given  effect  on  the  books. 

The  excess  of  actual  profits  over  those  given  effect 
constitutes  the  Secret  Reserve. 

The  method  we  have  outlined  in  connection  with  the 
valuation  of  inventories,  particularly  those  relating  to 
investments  that  have  a  readily  determinable  realization 
value,  creates  to  a  certain  degree  a  Secret  Reserve.  This, 
however,  is  but  a  conservative  estimate  of  profit,  whereas 
in  general,  a  Secret  Reserve  may  be  construed  to  mean  an 
arbitrary  reduction  of  actually  realized  profits. 

The  purpose  of  a  Secret  Reserve  usually  is  to  retain 
in  the  business  sums,  which,  if  they  appeared  on  the  books 
would  be  demanded  as  dividends  or,  in  the  case  of  public 
service  corporations,  to  make  the  profits  appear  but  nor- 
mal in  proportion  to  the  capital  involved,  so  that  the 
public  will  not  feel  that  the  charges  for  services  are  in 
excess  of  what  they  should  be  or  that  the  profits  are  the 
result  of  a  monopoly  rather  than  of  service,  and,  in  the 
case  of  the  majority  of  corporations,  to  escape  taxation. 

The  usual  mode  of  procedure  in  building  up  a  Secret 
Reserve  is  to  make  exceptionally  large  charges  against 
Revenue  to  cover  anticipated  losses,  such  as  depreciation, 
bad  debts,  etc.,  to  charge  it  with  expenses  as  they  occur 
but  which  have  already  been  provided  for  in  the  Reserve 
Account,  or  with  purchases  which  should  properly  be 
capitalized,  by  writing  off  Goodwill  or  Organization  Ex- 
penses, or  by  undervaluing  inventories.  It  might  alsa 


184  ACCOUNTING  PRINCIPLES 

be  accomplished  by  giving  effect  to  liabilities  that  do 
not  exist  but  we  believe  this  practice  is  very  unusual. 

The  advantages  of  a  Secret  Reserve  are  that,  in  the 
case  of  a  business  whose  profits  are  fluctuating,  a  normal 
rate  of  increase  may  be  shown,  exceptional  losses  may 
be  endured  without  an  apparent  effect  on  the  stability 
of  the  concern,  the  business  may  be  strengthened  and, 
where  additional  capital  is  required,  but  where  the  tend- 
ency of  the  stockholders  is  to  demand  all  surplus  earn- 
ings as  dividends,  it  may  be  secured. 

Its  disadvantages  are  that  the  accounts  and  reports 
do  not  show  the  proper  status  of  the  business;  an  esti- 
mate of  valuation  based  on  reports  must  be  inaccurate 
and  may  be  used  fraudulently  by  those  in  possession  of 
a  knowledge  of  the  true  state  of  affairs;  losses  due  to 
speculation  or  mismanagement  may  be  concealed  and 
assets  that  have  been  fraudulently  disposed  of  may  be 
entirely  erased  from  the  books.  When  the  amount  of  the 
reserve  is  given  effect  for  any  purpose  by  placing  it  on 
the  books  it  may  be  exaggerated  with  a  consequent  infla- 
tion of  proprietorship  and  of  profits  or,  where  it  is  cre- 
ated or  adjusted  by  tampering  with  inventories,  the  true 
proportion  of  profits  cannot  be  ascertained. 

The  propriety  of  creating  a  Secret  Reserve  seems  to 
us  to  be  well  answered  in  the  preceding  paragraphs  for, 
surely,  no  practice  which  has  so  few  good  points  should 
be  looked  upon  with  favor  where  there  are  so  many  ques- 
tionable features.  Still,  in  justice  to  the  practice,  we 
must  admit  that  the  policy  of  the  largest  and  most  con- 
servative institutions  in  the  country  favor  it  and,  so  long 
as  the  object  of  the  reserve  is  good  and  the  good  intent 
is  conscientiously  followed  and  also  that  it  appears  neces- 
sary in  the  interest  of  the  business,  there  is  a  possibility 
that  the  end  justifies  the  means. 


RESERVES  185 


C.  P.  A.  Questions 

1.  Do  you  consider  there  is  any  distinction  between 
/'Reserve  Fund"  and  "Reserve  Account?"    What  are  your 

reasons?     (111.) 

2.  What  is  your  understanding  of  the  term  "Reserve 
for  Doubtful  Debts,"  and  how  would  you  establish  it  upon 
the  ledger?     (111.) 

:>.  Mow  would  you  suggest  that  a  trading  or  manu- 
facturing concern  should  make  provision  for  known  or 
uncertain  losses  through  bad  debts?  (XXX.) 

4.  A  concern  owning  a  fleet  of  twenty  vessels  decides 
to  carry  their  own  insurance.    How  will  this  be  dealt  with 
Ovi  their  books  and  at  the  close  of  each  fiscal  year?     (111.) 

5.  An  old  established  and  highly  prosperous  business 
is  transferred  in  1900  to  a  company  which  pays  the  pro- 
prietors |300,000  for  all  fixed  assets  and  f  50,000  for  Good- 
will.    In  1!)09  the  company  has  accumulated  |125,000  of 
undivided  profits  and  the  directors  decide  to  charge  off 
the  entire  item  of  Goodwill.     What  effect  will  this  have 
upon  the  accounts?     (111.) 

(>.  Corporation  "X"  makes  a  practice  *of  charging  to 
expense  and  carrying  to  depreciation  reserve  account 
every  half  year  a  certain  percentage  of  the  book  value 
of  its  plant  and  machinery.  What,  in  your  opinion,  is  the 
correct  method  of  dealing  in  this  case  with  Repairs  and 
Renewals ;  i.  e.,  should  the  latter  be  charged  to  Profit  and 
Loss,  or  can  they  properly  be  charged  to  Depreciation 
Reserve  Account?  Give  reasons  for  your  answer.  (Wash.) 

7.  What  do  you  consider  the  best  way  of  entering  on 
the  books  of  a  manufacturing  company  the  amount 


186  ACCOUNTING  PRINCIPLES 

written  off  to  profit  and  loss  for  depreciation  of  (a) 
buildings,  (b)  large  or  fixed  tools,  (c)  small  or  expense 
tools?  (N.  Y.) 

8.  Name  the  advantages  or  disadvantages  of  the  fol- 
lowing two  methods  of  bringing  on  to  the  books  of  a 
company  the  depreciation  of  its  machinery : 

(a)  Crediting  Machinery  Account  with  ten  per  cent 
of  the  balance  of  the  account  each  year  and  charging 
Profit  and  Loss. 

(b)  Crediting  a  Reserve  for  Machinery  Depreciation 
with  ten  per  cent  of  the  balance  of  the  account  each  year 
and  charging  Profit  and  Loss.     (111.) 

9.  In  reviewing  the  schedules  of  open  customers'  ac- 
counts receivable  for  the  purpose  of  setting  up  a  reserve 
against  irrecoverable  amounts,  how  would  you  proceed? 
(111.) 

10.  A  firm  of  brickmakers,  under  the  terms  of  their 
20  years'  lease,  agree  that  at  the  close  of  the  term  they 
will  level  the  ground,  cover  it  with  soil  and  generally 
restore  it  to  previous   conditions   for   agricultural   pur- 
poses. 

(a)  How  would  you  deal  with  this  liability  in  the 
accounts  of  the  firm? 

(b)  Assume  5  years  of  term  have  expired  and  none 
of  the  work  done  and  no  provision  made.     How  would 
you  adjust  matters  at  this  date?     (Penn.) 

11.  Give  your  views  as  to  the  better  way  of  carrying 
property  accounts  in  a  manufacturing  business,  whether 
at  cost  or  value.     Give  also  the  manner  of  treating  de- 
preciation under  each  method.     (111.) 

12.  You  are  employed  to  audit  the  accounts  of  the 
Utility  Mills  and  find  that  the  machinery  after  having 
been  regularly  depreciated  for  a  number  of  years  has  been 


RESERVES  187 

valued  by  an  independent  appraiser  at  a  sum  considerably 
in  excess  of  the  book  value,  and  the  company  has  appre- 
ciated the  machinery  item  in  the  balance  sheet  by  such 
increased  value.  How  would  you  suggest  that  the  cor- 
responding credit  should  be  dealt  with?  Would  such 
appreciation  be  available  for  distribution  in  the  shape  of 
a  dividend?  (111.)  See  Chapter  XIII. 

13.  On  an  independent  appraisal  being  made  of  the 
machinery  and  tools  of  an  engineering  business,  of  which 
you  are  auditor,  it  is  found  that  the  appraised  valuation 
is  in  excess  of  the  book  valuation.    It  is  desired  ,to  set  up 
the  appraised  valuation  on  the  books.     How  should  this 
be  done? 

NOTE. — In  this  question  the  term  "book  valuation''  is 
to  be  understood  as  meaning  the  balance  of  the  Machinery 
a. id  Tools  Account,  less  the  balance  to  the  credit  of  De- 
preciation Reserve  Account — a  provision  for  depreciation 
having  been  made  annually  and  credited  to  the  latter. 
(Wash.) 

14.  In  three  successive  fiscal  years  a  manufacturing 
corporation  values  its  supplies,  etc.,  in  hand  at  cost,  with 
deduction  for  deterioration  as  follows:  At  end  of  first 
year  5% ;  at  end  of  second  year  10% ;  at  end  of  third 
year  15%.     With  the  inventory  taken  on  this  basis  the 
profit  for  the  second  year  did  not  equal  the  dividends 
declared  and  surplus  was  intrenched  upon ;  in  the  third 
year  the  dividend  paid  was  so  much  in  excess  of  profits 
that  the  surplus  was  entirely  exhausted  and  a  debit  bal- 
ance created  in  the  profit  and  loss  account. 

In  auditing  the  books,  how  would  you  treat  the  above 
condition  in  your  report?  (Penn.) 

15.  What  do  you  understand  by  the  term  "secret"  or 
"hidden"  reserves?     Mention   four  bona  fide  uses  of  a 


188  ACCOUNTING  PRINCIPLES 

secret  reserve  and  state  your  opinion  as  to  the  propriety 
or  otherwise  of  the  creation  of  such  reserves,  giving  rea- 
sons. (Mich.) 

16.  Is  there  any  reason  why  the  Goodwill   carried 
as  an  asset  on  the  books  of  a  growing  and  prosperous 
manufacturing  concern  should  be  depreciated,  amortized 
or  otherwise  written  off,  and  if  so  what  would  be  the 
effect  of  such  depreciation,  amortization  or  writing  off? 
(N.  Y.) 

17.  Name  two  ways  in  which  such  a  reserve  (Secret) 
may  be  created  and  suggest  a  purpose  for  such  creation. 
(Wash.) 

18.  What    are    ''Hidden    Reserves?"      Express    your 
opinion  on  their  soundness  or  otherwise  from  the  view- 
point of  a  shareholder,  a  director,  and  the  auditor  of  a 
company  respectively?      (111.) 

19.  State  the  different  ways  of  creating  a  Secret  Re- 
serve, and  also  the  extent  to  which  you  consider  it  per- 
missible.    (XXX.) 

20.  On  an  independent  appraisement  being  made  of 
the  physical  assets  of  a  manufacturing  corporation,  the 
appraisement  shows  appreciations  and  depreciations,  as 
compared  with  book  values,  as  follows: 

Real  Estate,  Appreciation $20,000.00 

Buildings,  Depreciation  3,000.00 

Machinery,  Depreciation  2,500.00 

Tools,   Depreciation   3,000.00 

The  directors  desire  to  bring  the  book  values  into 
agreement  with  the  appraisement.  Draft  entries  to  show 
how,  in  your  opinion,  this  should  be  done.  (Wash.) 


RESERVES  189 

21.  What,  in  your  opinion,  would  be  the  proper  record 
for  a  business  corporation  to  make  of  an  appropriation 
from  its  surplus  profits  for  the  amount  of  a  permanent 
investment  in  property?     (N.  Y.) 

22.  It  is  agreed  by  the  directors  of  a  manufacturing 
company  that  certain  depreciation  should  be  allowed,  but 
that  it  is  desirable  to  let  the  plant  account  stand  on  the 
books  at  cost  value.     How  would  you  as  auditor  manage 
to  meet  the  situation?     (N.  Y.) 

23.  By  what  accounting  method   may   regular   pro- 
vision be  made  for  the  cost  of  replacements  or  renewals 
from  time  to  time  that  are  not  in  the  nature  of  ordinary 
repairs  and  that  tend  to  maintain  or  to  restore  the  value 
and  efficiency  of  the  plant?     (N.  Y.) 

24.  A  public  service  corporation  that  regularly  sets 
aside  from  its  profits  a  sufficient  amount  to  provide  for 
depreciation,  removes  part  of  its  old  plant  and  replaces 
it  with  a  larger  and  more  costly  one.     The  old  plant  is 
sold  for  scrap.    How  should  the  cost  of  the  new  plant  and 
the  proceeds  from  the  sale  of  the  old  plant  be  treated  in 
the  accounts  of  the  company?    Give  reasons.     (N.  Y.) 

25.  Should  provision  be  made  out  of  revenue  to  pro- 
vide for  discount  on  accounts  receivable  outstanding  after 
the   date   of   closing?      Give    reasons    for   your   answer. 

(N.  Y.) 


CHAPTER  XVIII 

Reserve  Investments 

In  connection  with  a  great  many  lines  of  business  it  is 
desirable  to  make  certain  that  quickly  convertible  assets 
will  be  available  for  use  along  a  particular  line  at  some 
future  date;  possibly  in  connection  with  the  payment  of 
a  debt  through  which  considerable  loss  may  result  if  cash 
is  not  available  to  meet  it  at  the  time  it  matures ;  to  pro- 
vide against  a  fire  loss ;  to  assure  the  availability  of  funds 
to  complete  existing  contracts ;  to  continue  operations  ;  or, 
as  is  sometimes  the  case,  to  provide  for  the  redemption 
of  an  issue  of  Preferred  Stock  which  is  possibly  to  be  re- 
deemed at  a  sum  in  excess  of  par  and  which  it  is  very 
desirable,  from  the  standpoint  of  the  common  stockhold- 
ers, to  liquidate;  or,  as  in  the  case  of  permanent  under- 
takings, to  pay  such  portion  of  a  debt  that  is  not  desired 
refunded  at  maturity. 

The  only  way  that  a  firm  can  be  certain  of  having 
funds  available  at  the  time  they  wish  them,  is  to  set  aside 
from  time  to  time  such  sums  as  it  can  spare  and  invest 
them  in  such  securities  as  will  be  safe  and  may  be  readily 
converted  into  cash,  or  to  deposit  them  in  some  reliable 
bank. 

Where  such  an  accumulation  is  made  by  setting  aside 
certain  amounts  at  stated  periods,  it  is  usually  considered 
as  a  Sinking  Fund  Investment,  otherwise  it  is  usually 
known  as  a  Reserve  Fund  Investment.  The  use  of  the 
terms  has  not,  as  yet,  been  sufficiently  restricted  in  ac- 
counting terminology  to  warrant  the  assumption  that  the 
above  assertion  will  accurately  apply  in  all  cases  where 


RESERVE  INVESTMENTS  191 

they  are  used,  but  we  believe  it  properly  restricts  their 
use. 

The  investment  might  be  operated  entirely  separate 
from  any  reserves  if  conditions  were  such  that  there  was 
no  necessity  of  creating  reserves  to  replenish  the  working 
capital ;  or  it  may  be  operated  in  connection  with  a  Re- 
serve Account  to  provide  for  the  purchase  of  assets  to 
replace  those  that  have  been  discarded  by  the  business. 
This  use,  however,  seems  almost  unwarranted  except  in 
rare  cases,  for  it  is  very  seldom  that  the  assets  would  re- 
quire replacing  with  such  rapidity  that  they  could  not  be 
cared  for  without  drawing  upon  an  investment  outside 
of  the  business.  The  most  important  use  covers  the 
specific  placing  aside  of  trust  funds  which  have  already 
been  provided  out  of  Undivided  Profits  and  which  already 
appear  in  the  books  to  the  credit  of  some  Reserve  Fund. 

The  investment  of  the  funds,  in  trust,  in  no  way  effects 
the  liability  to  the  trust;  hence,  the  books  will  show  the 
liability  existing,  but  after  an  investment  is  made  they 
will  show  further  that,  instead  of  having  the  trust 
absorbed  in  the  business,  it  has  been  specifically  provided 
for  and  removed  from  the  business.  This,  then,  gives  us 
two  accounts  each  relating  to  the  same  trust,  one  showing 
the  existing  liability  and  the  other  the  provision  that  has 
been  made  for  it.  Each  of  these  accounts  is  operated  en- 
tirely separate  of  the  other  and  any  fluctuation  or  losses 
that  may  affect  one,  will  not  necessarily  affect  the  other, 
viz.,  excessive  losses  may  reduce  or  entirely  erase  either 
of  the  accounts  but  the  other  may  still  remain  intact  and 
may  ultimately  accomplish  its  purpose. 

The  reason  for  creating  the  fund  in  the  first  place  was 
to  retain  and  invest  in  the  business  certain  sums  which 
we  believed  represented  our  obligation  to  the  trust.  By 
removing  and  specifically  investing  like  sums  and  deter- 


192  ACCOUNTING  PRINCIPLES 

mining  that  the  investment  is  to  be  used  solely  for  the 
purpose  of  the  trust,  we  have  made  its  ultimate  payment 
doubly  certain.  If  the  purpose  of  the  trust  is  of  great 
importance  we  might  go  still  another  step,  as  is  often 
done  in  connection  with  the  redemption  of  bonds,  and 
place  the  investment  entirely  out  of  our  own  hands  and  in 
those  of  a  trustee  with  instructions  to  use  the  funds  that 
accrue  in  following  the  terms  of  the  trust.  This  is  the 
most  certain  method  of  providing  for  the  availability  of 
current  assets  at  the  time  they  are  required,  for  if,  as  cur- 
rent assets  are  removed  from  the  business,  they  are  imme- 
diately replaced  by  current  profits  reserved  from  those 
available  and  intended  for  dividends,  there  is  but  a  slight 
chance  that  the  business  will  be  crippled  through  a  short- 
age of  working  capital  and  also,  as  the  investment  is  not 
subject  to  the  changing  mpdes  of  a  board  of  directors 
whose  membership  varies  from  year  to  year,  there  is  a 
slight  possibility  that  the  fund  wrill  be  applied  to  some 
other  purpose. 

In  connection  with  the  investment  of  reserves,  it 
appears  that,  so  long  as  the  majority  of  industrial  con- 
cerns are  compelled  to  borrow  money  with  which  to  con- 
duct operations,  it  is  inadvisable  to  create  investments, 
which  must  necessarily  bear  a  very  low  rate  of  interest, 
to  make  certain  the  availability  of  current  assets  should 
they  be  ultimately  required,  while  the  funds  invested 
can  be  used  to  such  a  good  purpose  in  the  operation  of 
the  business,  unless,  of  course,  the  certainty  of  avail- 
ability of  such  funds  is  very  essential  to  its  welfare. 
Such  a  case  arises  in  connection  with  an  Insurance  Fund 
which  would  be  absolutely  useless  if  it  were  invested  in 
the  business  and  liable  to  destruction  with  the  rest  of  the 
business. 

Investments  of  Eeserves  are  provided  for,  under  con- 


RESERVE  INVESTMENTS  193 

tract,  in  connection  with  various  bond  issues  but,  as 
the  trustees  are  usually  authorized  to  purchase  the  bonds 
of  the  company  with  its  trust  funds  thereby  securing  the 
same  rate  of  interest,  its  ill  effects  are  to  a  great  extent 
nullified. 

In  the  C.  P.  A.  examinations,  it  is  often  required  to 
determine  which  of  certain  accounts  pertaining  to  Re- 
serves and  Investments,  represent  assets  and  which  liabili- 
ties.  Such  a  question  should  be  answered  very  fully,  out- 
lining the  possibility,  whenever  it  exists,  of  the  account 
being  either  a  debit  or  a  credit.  As  an  example,  take  the 
term  "Investment  Fund."  This  might  represent  certain 
sums  reserved  out  of  profits  or  possibly  certain  quick 
assets  available  for  investments.  In  the  former  case  it 
would  appear  as  a  credit  and  in  the  latter  as  a  debit.  As 
a  further  example,  take  the  term  "Sinking  Fund."  The 
usual  use  of  the  term  represents  an  investment  but  still 
it  is  also  used  to  represent  not  only  the  Sinking  Fund 
Investment,  but  also  the  Sinking  Fund  Reserve.  It  is  very 
seldom,  if  ever,  used  entirely  as  a  credit  without  a  cor- 
responding debit. 

Other  terms  that  occur  are  "Contingent  Fund,"  repre- 
senting a  provision  for  contingencies,  and  "Redemption 
Fund,"  providing  for  the  redemption  of  some  debt,  either 
of  which  may  be  debits  or  credits  or  both,  with  a  slight 
preponderance  in  favor  of  the  debit. 

To  determine,  arithmetically,  the  amount  of  the  in- 
stallments required  to  accumulate  a  particular  sum 
during  a  given  time,  ascertain  the  compound  interest  on 
$1.00  for  the  period  the  first  installment  will  run,  then 
from  the  figures  you  have  used,  ascertain  the  accumula- 
tion of  a  like  sum  deposited  or  invested  at  the  end  of  each 
succeeding  period.  The  total  of  these  will  represent  the 
value  of  an  annuity  of  $1.00  for  the  period  of  the  sinking 


194  ACCOUNTING  PRINCIPLES 

fund.  Dividing  this  amount  into  the  amount  which  it  is 
desired  to  accumulate  will  give  the  amount  of  the  required 
installments. 

To  illustrate,  the  value  of  $1.00  at  4%  compound  in- 
terest, has  been  ascertained  as  follows: 

0  years $1 . 00 

1  years 1 . 04 

2  years 1.0816 

3  years 1 . 124864 

4  years 1.16985856    $5.41632256 

hence,  $1.00  deposited  at  the  end  of  each  year  for  five 
years  at  4%  interest,  compounded  annually,  will  at  that 
time,  amount  to  $5.41632256.  This  sum  divided  into  any 
amount  it  is  desired  to  accumulate  under  these  conditions 
will  give  the  amount  of  the  annual  contribution. 

At  the  time  the  contribution  is  made,  Cash  is  removed 
from  the  usual  receptacle  and  invested  or  placed  in  the 
hands  of  a  trustee  for  investment.  The  entry  on  our 
books  will  be: 

Sinking  Fund  Investment  or  Trustee  X 

Cash  X 

Cash  placed  in  the  hands 
of  Trustee  for  investment 
to  provide  for 

Then  to  replenish  the  working  capital,  if  it  is  desired  to 
do  so,  we  will  make  the  entry : 

Undivided  Profits  X 

Reserve  Fund  for X 

The  above  amount  is  set 
aside  as  a  reserve  to  re- 
replenish  Working  Capital 

We  now  have  a  Sinking  Fund  Investment  and  a  Reserve 
Fund  both  referring  to  the  same  obligation,  but  each 
created  in  a  different  way  and  each  operating  independ- 
ently of  the  other.  Let  us  presume  that  at  the  end  of  the 


RESERVE  INVESTMENTS  195 

first  fiscal  year  the  trustee  receives  the  earnings  on  the 
investment.    Our  entry  is : 

Sinking  Fund  Investment  or  Trustee  X 

Sinking  Fund  Income  X 

Earnings  as  above 
reported  this  day. 

or,  if  the  investment  were  not  in  the  hands  of  the  trustee 
the  entry  would  be 

Cash  X 

Sinking  Fund  Income  X 

Cash  received  this  day 
as  income  on  Sinking  Fund 

and  when  the  income  is  invested : 

Sinking  Fund  Investment  X 

Cash  X 

The   income   received  is 
re-invested. 

We  now  have  on  our  books  an  account  representing 
the  income  derived  from  the  investment  and  we  must  de- 
termine what  is  to  be  done  with  it.  It  undoubtedly  rep- 
resents an  earning  on  an  investment  and  therefore  is  a 
credit  to  Undivided  Profits  or  some  account  that  is  sub- 
sidiary to  it.  We  are,  therefore,  at  liberty  to  close  it  into 
the  Reserve  Fund;  in  fact  the  Reserve  Fund  seems  to  be 
the  proper  place  for  it  as  the  Sinking  Fund  not  only  re- 
quires the  annual  installment  but  also  the  accretions  if 
it  is  to  amount  to  the  proper  sum  when  it  is  required  and, 
if  the  Reserve  Fund  is  to  be  the  complement  of  the  Sinking 
Fund  Investment,  it  should  likewise  receive  the  accretions. 
If  desired,  the  transfer  from  one  account  to  the  other 
could  be  made  through  the  Profit  and  Loss  Account  so  the 
latter  will  show  the  actual  income  from  all  sources  for  the 
period.  Unanticipated  profits  arising  through  the  man- 
ipulation of  investments  could  be  retained  in  a  separate 


196  ACCOUNTING  PRINCIPLES 

account  to  offset  any  unanticipated  losses  that  might 
occur. 

It  should  be  thoroughly  understood  that  there  is  no 
absolute  necessity  that  the  Sinking  Fund  Reserve  and 
the  Sinking  Fund  Investment  Accounts  agree.  They  are 
independent  of  each  other  and  although  it  is  desirable  that 
they  should  agree,  it  is  not  essential. 

Let  us  presume,  though,  that  instead  of  a  Reserve  Fund 
we  had  a  Reserve  Account  representing  the  Reserve  for 
Depreciation  and  that  this  amount  was  to  be  invested 
outside  the  business  to  provide  for  the  purchase  of  new 
machinery.  Our  entries  would  follow  very  closely  on  the 
lines  laid  out  as  will  be  noticed  by  the  following: 

Profit  and  Loss  (Manufacturing)  X 

Reserve  for  Depreciation  X 

The  annual  reserve  for 
depreciation  is  set  aside 

Reserve  Investment  for  replacing 

Fixed  Assets  X 

Cash  X 

The  annual  reserve  for 
depreciation  is  invested 
to  make  certain  the 
availability  of  Cash 
when  required 

and  later: 

Cash  X 

Income  on  Reserve  Investment  X 

Income  received  this  day 

but  now  we  have  an  account  representing  an  income  from 
an  investment  while  the  reserve  account  represents  a 
charge  against  Profit  and  Loss  and  is  not  a  subdivision 
of  Undivided  Profits ;  therefore,  assuredly  the  "Income  on 
the  Reserve  Investment"  cannot  be  closed  into  the  "Re- 
serve for  Depreciation."  One  is  a  portion  of  earnings 
and  the  other  is  an  anticipated  loss  or  expense  and  fur- 


RESERVE  INVESTMENTS  197 

thermore,  the  annual  charge  to  Profit  and  Loss  repre- 
sents the  value  consumed  during  the  year  in  the  way  of 
depreciation  and  it  should  not  be  reduced  in  any  way  by 
the  simple  investment  of  certain  funds  which  are  in  fact 
not  connected  with  depreciation  at  all.  We  will,  there- 
fore, in  this  case,  have  to  close  the  "Income  from  Re- 
serve Investments"  direct  into  Undivided  Profits  or  else 
allow  it  to  accumulate. 

From  the  above,  it  would  appear  that  a  Sinking  Fund, 
in  the  usual  sense  of  the  term,  could  not  properly  be  oper- 
ated in  connection  with  a  Reserve  Account,  for  a  Sinking 
Fund  infers  the  use  of  not  only  the  installments,  but  also 
the  accretions  in  the  accomplishment  of  its  purpose; 
whereas  the  Reserve  Account  could  not  and  should  not 
be  affected  by  the  accretions.  Of  course,  if  it  were  desired 
to  build  up  a  certain  sum,  say  to  replace  certain  machin- 
ery, this  could  be  accomplished  under  the  sinking  fund 
method,  but  the  amount  of  the  sinking  fund  installment 
would  not  affect  the  amount  of  the  depreciation.  The 
latter  would  be  slightly  greater  as  it  would  have  to  pro- 
vide for  the  same  amount  in  the  same  time  without  the 
benefit  of  the  earnings. 

It  should  be  remembered,  in  connection  with  the  above, 
that  the  Reserve  for  Depreciation  should  only  be  charged 
with  the  decrease  in  the  value  of  the  article  displaced 
after  it  has  been  ascertained.  The  amount  in  the  Reserve 
Investment  could,  however,  be  used  for  the  purchase  of 
new  assets  if  desired,  as  no  necessity  exists  requiring  that 
the  investment  be  expended  in  a  particular  manner. 

let  us  go  a  stei)  further  and  presume  that  the  bank 
in  which  we  deposited  a  portion  of  the  investment  had 
failed.  We  should  reduce  the  investment  by  the  amount 
of  the  loss  and  charge  it  to  Undivided  Profits.  The  Re- 
serve could  remain  as  it  was  but,  instead  of  being  spe 


198  ACCOUNTING  PRINCIPLES 

cifically  invested,  a  portion  of  it  would  now  have  to  be 
absorbed  by  the  business  or,  if  preferred,  the  two  ac- 
counts could  be  adjusted  to  correspond  by  throwing  the 
loss  into  the  Reserve;  or,  let  us  presume  that,  through 
a  number  of  years,  business  losses  had  resulted  which 
not  only  required  all  the  Undivided  Profits  to  cover  but 
now  require  a  portion  of  the  Reserve  Fund.  We  must 
reduce  the  Reserve  Fund  to  cover  the  deficit  for,  surely, 
it  would  be  incorrect  to  show  on  one  side  of  our  Balance 
Sheet  an  account  headed  "Deficit,"  while,  on  the  other 
side,  an  account  appears  representing  "Undivided 
(though  specially  allocated)  Profits."  Our  reduction  of 
the  reserve  fund  in  this  case  has  not  affected  the  invest- 
ment and  conditions  might  be  such  that  it  would  be  un- 
necessary to  draw  on  the  investment  at  all.  Dividends 
would,  of  course,  cease  during  the  period  of  the  losses. 

Let  us  presume,  further,  that  the  Investment  includes 
certain  bonds  which  have  been  purchased  either  above 
or  below  par.  It  is  self  evident  that  the  premium  or  dis- 
count would  have  to  be  adjusted  each  year  as  the  bonds 
approached  maturity  and  that  this  adjustment  would  have 
an  immediate  effect  on  the  income  derived  from  the  in- 
vestment. It  would  not,  however,  be  necessary  to  give 
effect  to  a  mere  fluctuation  in  market  quotations  covering 
bonds  held  for  permanent  investment. 

To  illustrate  still  further,  we  will  presume  that  we 
have  the  following  accounts  on  our  books : 

Balance  Sheet  of  the  "X"  Corporation 

Cash  X  Sundry  Liabilities  X 

Sundry  Assets  X  Dividends  Payable  X 

Sinking  Fund  Bonds  Payable  X 

Investment  X  Capital  X 

Reserve  Fund  X 

Undivided  Profit  X 

XXX  XXX 


RESERVE  INVESTMENTS  199 

We  will  also  presume  that  we  have  accumulated  a  suffi- 
cient sum  to  pay  off  the  existing  obligation.  We  now  con- 
vert the  Sinking  Fund  Investment  into  Cash  and  with  the 
cash  pay  off  the  bonds ;  or  possibly  a  portion  of  the  invest- 
ment includes  our  own  bonds  which  have  been  purchased 
by  the  trustee,  in  which  case  we  would  deduct  their  value 
from  both  the  Investment  and  the  Bonds  Payable  Account 
with  the  entry: 

Bonds  Payable  X 

Sinking  Fund  Investment  or  Trustee  X 

Bonds  cancelled  this  day 

After  closing  out  the  accounts  representing  the  fund 
and  the  investment,  we  have  the  following: 

Balance  Sheet  of  the  "X"  Corporation 

Cash  X  Sundry  Liabilities 

Sundry  Assets  X  Dividends  Payable 

Capital 

Reserve  Fund  X 

Undivided  Profit  X 


XXX  XXX 


The  necessity  of  the  trust  no  longer  exists,  hence  the  Re- 
serve Fund  may  be  dispensed  with  and  if  desired  closed 
into  its  major  account;  but,  as  undoubtedly  the  necessity 
of  having  additional  funds  has  not  decreased  since  the 
original  bond  issue  was  sold,  such  a  procedure  would  be 
imprudent  as  it  might  result  in  the  distribution  of  funds 
as  dividends  which  are  required  in  the  business. 

Another  plan  is  to  set  off  the  amount  of  the  Reserve 
Fund  against  any  immaterial  assets  that  may  appear 
in  the  books,  as  Goodwill,  where  it  represents  an  arbitrary 
loading  incidental  to  a  purchase  of  property  with  Stocks> 
or  Patents,  Mines,  etc.  acquired  under  like  conditions. 


200  ACCOUNTING  PRINCIPLES 

The  better  plan  seems  to  be  to  distribute  the  amount 
in  the  Reserve  Fund  as  a  stock  dividend,  thereby  not  only 
increasing  the  capital  stock  and  retaining  the  working 
capital,  but  satisfying  the  stockholders  as  well.  This 
virtually  amounts  to  capitalizing  the  earnings  and  gives 
us  the  following  balance  sheet : 

Balance  Sheet  of  the  UX"  Corporation 

Cash  X  Sundry  Liabilities  X 

Sundry  Assets  X  Dividends  Payable  X 

Capital  (including 

Reserve  Fund)  X 

Undivided  Profit  X 

XXX  XXX 


RESERVE  INVESTMENTS  201 


C.  P.  A.  Questions 

1.  Under  what  circumstances,  if  any,  would  it  be 
desirable  to  specifically  invest  a  Reserve  Fund?  What 
class  of  securities  should  it  be  invested  in?  (XXX.) 

'2.  Define  briefly,  the  following  terms:  Sinking  Fund, 
Contingent  Fund,  Reserve  Fund,  Redemption  Fund,  De- 
preciation Fund,  Investment  Fund.  Which  of  these  rep- 
resent assets  and  which  liabilities?  (111.) 

:>.  An  interurban  railway  company,  wishing  to  pro- 
vide against  possible  accidents,  adopted  the  plan  of  de- 
positing 2%  of  their  gross  receipts  each  month  in  a  local 
savings  bank  as  a  reserve  for  lliat  purpose,  charging  the 
funds  so  set  aside  to  an  account  which  they  designated 
••  Reserve  for  Accidents."  The  total  fund  for  the  year 
amounted  to  $4,869.26,  out  of  which  they  paid  $950  for 
accidents  occurring  and  settled  during  the  twelve  months, 
debiting  such  payment  to  the  Accident  Account,  and  leav- 
ing a  cash  balance  in  the  bank  on  December  31,  of 
$3,919.26. 

The  bookkeeper  endeavored  to  close  the  books  by  show- 
ing the  $4,869.26  as  a  charge  against  operations  for  the 
year  arising  out  of  accident  liability,  carrying  over  the 
balance  in  bank,  $3.919.26,  to  provide  for  future  acci- 
dents, and  making  a  corresponding  credit  to  the  "Reserve 
for  Accidents"  account.  This  left  the  company  with  cash 
assets  of  $3,919.26  not  represented  on  the  books. 

Wherein  did  the  bookkeeper  err  and  what  entries 
si  ion  Id  have  been  made  to  show  the  transaction  correctly? 
(111.) 

4.  At  the  beginning  of  a  certain  year  a  company  lias 
a  Reserve  Fund  amounting  to  $5,000  invested  in  bonds, 


202  ACCOUNTING  PRINCIPLES 

and  a  balance  to  the  credit  of  Surplus  Account  amount- 
ing to  $7,500.  At  the  close  of  the  year,  it  is  ascertained 
that  the  company's  operations  have  resulted  in  a  loss  of 
$10,000.  You  are  requested  to  show  the  effect  of  this 
result  upon  the  accounts  named.  (Adapted  from  D.  A.  A.) 

5.  What  is  a  reserve  account?    How  may  it  be  prop- 
erly established  and  for  what  purpose?     What,  if  any, 
contra  account  should  be  maintained?     Under  what  cir- 
cumstances should  these  accounts  be  maintained?    Why? 
(N.  Y.) 

6.  Under  the  condition  that  a  general  mortgage,  or 
trust  indenture,  makes  provision  for  regular  payments 
to  the  trustee  of  a  sinking  fund  which,  with  accretions 
from  the  investment  thereof,  is  to  provide  for  the  re- 
demption of  bonds  at  their  maturity,  state  what  account- 
ing should  be  made  in  respect  to  the  payments  into  such 
fund  of  its  interest  or  profit  accretions.     Indicate  what, 
if  any,  distinction  should  be  made  between  the  interest 
and  the  profits.    Give  reasons.     (N.  Y.) 

7.  Distinguish  between  a  sinking  fund  and  a  depre- 
ciation fund.     Show  the  reason  for  the  creation  of  each 
fund,  and  state  how  each  is  placed  on  the  books  of  a  com- 
pany.    (N.  Y.) 

8.  How  may  a  reserve  account  (Reserve  Fund)   and 
a  sinking  fund,  both  relating  to  the  payment  of  the  same 
debt  be  simultaneously  operated?     What  purpose  is  ac- 
complished thereby  and  how  do  said  accounts  respectively 
appear  on  the  balance  sheet?     (N.  Y.) 

9.  On  the  first  of  July,  1905,  a  company  borrowed 
$100,000.00  at  4%  per  annum,  payable  half  yearly,  pay- 
ment of  loan  to  be  made  at  the  end  of  ten  years,  at  105%. 
It  was  decided  to  set  aside  out  of  profits  such  a  sum  as 
would,  with  interest,  at  4%  per  annum,  provide  for  the 
payment  of  the  premium  on  the  loan  at  end  of  the  period. 


RESERVE  INVESTMENTS  203 

It  has  been  ascertained  that  the  proper  annual  charge 
to  Undivided  Profits  is  $416.46. 

From  the  information  given,  write  up  the  books  in 
detail  for  the  first  two  years  and  also  show  the  journal 
entries  that  would  have  to  be  made  at  the  end  of  the 
ten  years  to  close  out  the  various  accounts.  (XXX.) 

10.  The  firm  of  "A.  B.  C.  Co."  own  a  plant  worth 
$10,000.00  and  have  been  writing  off  a  sum  averaging 
$1,000.00  per  year  for  depreciation.     They  have  decided 
that  it  would  be  to  their  advantage  to  take  this  money 
and  invest  it  in  profit  bearing  securities  as  a  reserve  with 
which  to  buy  new  machinery  whenever  it  becomes  neces- 
sary. 

On  January  1st  of  each  year  they  invest  this  sum  in 
stocks  and  bonds.  Presuming  that  the  interest  and  divi- 
dends amount  to  6%  per  annum  and  also  that  it  is 
payable  December  31st,  what  entry  would  you  make  in 
the  books  at  the  end  of  the  first,  second  and  third  years? 

At  the  end  of  the  third  year  machinery  is  purchased 
to  the  amount  of  $2,500.00,  to  replace  other  machinery 
costing  $2,000,  which  has  a  residual  value  of  $1,400.00, 
and  a  book  value  of  $1,500  and  which  is  to  be  paid  for 
from  the  sale  of  a  portion  of  the  stocks  and  bonds  that 
comprise  the  fund.  What  entries? 

What  is  the  status  of  the  Sinking  Fund  Investment. 
Sinking  Fund  Income  and  Reserve  for  Depreciation  Ac 
counts?  (XXX.) 

11.  Explain  the  nature  and  operations  of  an  Insur 
ance  Fund.    Is  such  a  fund  applicable  to  all  lines  of  busi- 
ness, and,  if  not,  why?     (XXX.) 

12.  What  is  a  sinking  fund?     How  should  the  ac- 
count be  treated  on  the  books  of  a  corporation?     (N.  Y.) 

13.  Define:  Reserve  Account,  Reserve  Fund.  (Wash.) 


204  ACCOUNTING  PRINCIPLES 

14.  The  American  Manufacturing  Company  on  Jan. 
1,   1909,  placed  in  service  a  piece  of  machinery  which 
would  depreciate,  according  to  its  chief  engineer,  at  the 
rate  of  15%  per  annum.     The  original  cost  of  this  ma- 
chinery was  |84,000.00  and  the  board  of  directors  agree 
to  set  aside  annually  a  sinking  fund  which,  together  with 
the  interest  thereon,  will  amount  to  the  original  cost  at 
the  end  of  the  prospective  life  of  the  machinery.     This 
sinking  fund  is  to  be  deposited  with  a  trust  company  on 
Dec.  31st  of  each  year  and  a  corresponding  amount  at 
the  end  of  the  last  partial  year  of  the  life  of  the  ma- 
chinery ;  interest  is  to  be  credited  by  the  trust  company 
at  each  of  these  dates  at  the  rate  of  4%   per  annum. 
Show  how  the  amount  of  the  annual  sinking  fund  pay- 
ment may  be  arrived  at  and  prepare  a  detailed  statement 
for   the   board    of    directors,    proving   that    the    amount 
so  obtained  is  correct.     (N.  Y.) 

15.  A  mortgage  provides  for  a  sinking  fund  to  be 
accumulated  in  the  hands  of  a  trustee  from  profits  prior 
to  dividend  payments.     Prepare  skeleton  balance  sheet 
to  disclose  the  state  of  the  fund,  dividends  declared  and 
payable,  appropriations  of  profits  for  purpose  of  the  fund 
and  an  unappropriated  surplus.    What  effect  would  losses 
in  excess  of  such  unappropriated  surplus  have  on  the 
sinking  fund?     (N.  Y.) 

16.  An  industrial  corporation  has  an  issue  of  bonds 
falling  due  in  fifteen  years,  and  has  accumulated  a  fund 
annually  from  profits  with  which  to  pay  off  the  bonds 
at  maturity.     The  Fund  is  invested  in  interest-bearing 
securities.     How  will  the  payment  of  the  bonds  affect 
the  figures  and  items  in  the  Balance  Sheet?     (HI.) 

17.  Describe  briefly  how  you  would  bring  upon  the 
books  of  a  company  a  sinking  fund  created  for  the  pur- 
pose of  finally  redeeming  its  bonded  indebtedness.    How 


RESERVE  INVESTMENTS  205 

would  you  treat  the  assets  of  this  fund  and  the  invest- 
ment of  same?  Finally,  how  would  you  show  the  con- 
dition of  this  fund  in  the  balance  sheet  of  the  company? 
(111.) 

18.  What  meaning  does  the  appearance  of  a  sinking 
fund  account  in  a  balance  sheet  convey  to  you?     Should 
a  sinking  fund  represent  specific  investments,  or  may  it 
be  offset  by  equivalent  ledger  on  tries?     i  111.  i 

19.  Outline  fully  the  operation  of  a  Sinking  Fund. 
(XXX.i 

20.  State  three  purposes  for  which  a  Sinking  Fund 
may  exist  and  give  examples  of  each.     (111.) 

21.  What  entries  appear  where  bonds  have  been  re- 
deemed with  the  cash  turned  over  to  the  trustees  and 
where  the  bonds  are  cancelled?     (XXX.) 

22.  What   are   the   advantages   or  disadvantages   of 
retiring  a  debt  by  the  Sinking  Fund  method?     (XXX.) 

23.  To  what  account  should  the  interest  received  on 
Sinking  Fund  investments  be  credited?     (XXX.) 

24.  After  the  Bonds  Payable  and  the  Sinking  Fund 
Investment  accounts  have  been  wiped  out  and  there  only 
remains  the  Sinking  Fund  Reserve  (Credit),  what  should 
be  done  with  the  Sinking  Fund  Reserve  Account?  (XXX.) 

25.  In  the  case  of  a  perpetual  undertaking,  is  it  neces- 
sary that  the  Sinking  Fund  be  arranged  to  retire  the 
entire  bond  issue?     (XXX.i 

-<;.  An  individual  buys  a  fleet  of  ships.  He  then 
forms  a  corporation  to  take  them  over  at  double  the  sum 
paid  by  him,  payable  one-half  in  debenture  bonds  of  the 
company,  and  one-half  in  its  capital  stock.  A  sinking 
fund  is  to  be  provided  for  the  gradual  retirement  of  the 


206  ACCOUNTING  PRINCIPLES 

debenture  bonds.  A  public  accountant  is  called  in  at  the 
end  of  five  years  to  make  up  the  accounts.  He  insists 
on  creating  a  depreciation  fund  based  on  the  full  con- 
sideration paid  by  the  corporation.  The  directors  argue 
that  the  depreciation  fund  should  be  based  on  the  amount 
of  debenture  bonds  issued,  on  the  theory  that  the  capital 
stock  issued  to  the  vendor  was  in  the  nature  of  a  bonus 
and  did  not  represent  any  real  value.  State  your  views 
regarding  the  two  propositions.  (N.  Y.) 

27.  A  reserve  fund  of  f 250,000  has  been  set  aside  out 
of  the  profits  of  a  company  and  invested  in  government 
securities  at  par.  How  should  the  fund  and  investment 
appear  on  the  balance  sheet  of  the  company  (a)  if  the 
value  has  increased,  (b)  if  the  value  has  decreased?  Give 
reasons  for  your  answer.  (N.  Y.) 


CHAPTER  XIX 

Miscellaneous  Subsidiary  Accounts 

Another  use  of  subsidiary  accounts  beside  that  of 
retaining  profits  or  assets  of  one  period  to  adjust  that 
period  or  to  provide  for  some  other  period,  lies  in  con- 
nection with  the  subdivision  of  accounts ;  the  most  im- 
portant of  which  refer  to  the  Cash  Account  and  the 
Sales  Account. 

Divisions  of  Cash  Account. 

In  the  majority  of  concerns,  it  is  desirable  to  separate 
the  cash  items  into  a  number  of  subsidiary  accounts,  each 
representing  some  depository  or  fund.  The  principal  of 
such  accounts  are  Bank  Account  and  Petty  Cash. 

Bank  Account. 

The  cash  with  the  bankers  may  be  distributed  over 
several  banks  in  the  same  or  in  several  cities  according 
to  the  scope  of  the  business,  in  which  case  an  account 
should  be  maintained  for  each  bank. 

In  practice,  it  very  seldom  happens  that  the  balance 
to  our  credit  on  the  bankers'  books  agrees  with  the  balance 
our  books  show  to  be  on  deposit.  This  is  accounted  for 
by  checks  outstanding  or  other  items  which  have  not  been 
entered  in  both  sets  of  books  and,  in  order  to  verify  the 
accuracy  of  the  accounts,  it  becomes  necessary  to  reconcile 
them. 

Reconciliation  of  Bank  Pass  Book  and  Bank  Account. 

This  is  accomplished  by  taking  the  balance  of  one  of 
the  accounts  and  increasing  or  decreasing  that  sum  by  the 


208  ACCOUNTING  PRINCIPLES 

amount  of  each  item  that  appears  in  only  one  of  the  ac- 
counts. 

After  all  of  these  single  items  have  been  ascertained 
and  properly  deducted  or  added  to  the  original  balance, 
the  new  balance  should  represent  the  amount  of  the 
balance  displayed  by  the  other  account.  The  form  which 
the  statement  may  take  varies  with  the  conditions  and 
the  views  of  the  accountant;  but,  in  general,  it  is  prefer- 
able to  arrange  the  statement  so  that  no  deductions 
appear. 

The  following  is  a  desirable  form : 

Reconciliation  of  the   account  with  the 

First  National  Bank  of . , 

as  at  July  1st,  191 

Balance  per  our  books  X 

Checks  outstanding: 

# X 

# X 

#  XX  XXX 


Deposits  in  transit: 

June  29,  X 

June  30,  X  X 

Balance  per  Bank  Pass  Book  X  XXX 

Another  form,  more  popular  than  the  first,  but  having 
the  objection  of  deductions  is: 

Reconciliation  of  the  Cash  Account  with  the 

First  National  Bank  of 

as  at  July  1st,  191 

Balance  per  bank  statement 

Less  outstanding  checks  as  listed  below  X 


Balance  per  Cash  Account  (Ex.  A.)  XXX 

Outstanding  Checks: 

# X 

X 


Total  as  above  XXX 


MISCELLANEOUS  SUBSIDIARY  ACCOUNTS  209 

Internal  Check. 
Lapping  System. 

In  devising  a  system  of  internal  check,  it  is  desirable 
that  all  payments  be  made  by  check  and  that  all  receipts 
of  whatever  nature  be  deposited  daily  in  the  bank. 

The  advantage  of  depositing  the  total  receipts  daily 
lies  in  the  ease  with  which  the  cash  receipts  may  be  traced 
into  the  bank. 

If  the  total  receipts  represent  any  particular  sum,  the 
total  deposits  must  equal  a  like  sum  and  a  comparison 
of  the  two  automatically  verifies  both  of  the  lists;  the 
only  opportunity  for  fraud  lies  in  that  cash  receipts  may 
be  entirely  abstracted,  in  which  case  the  payee's  account 
will  either  appear  incorrectly  on  the  books  or  will  be 
credited  from  some  other  source  with  the  amount  re- 
moval ;  in  either  case,  the  possibility  of  detection  being 
very  great,  the  practice  is  greatly  restricted.  The 
amount  abstracted  in  any  one  day  may,  of  course,  be  re- 
placed in  the  succeeding  day  writh  the  receipts  of  that  day 
and  a  like  or  greater  amount  taken  from  each  succeeding 
day  to  replace  the  shortage  of  the  preceding  period.  In 
this  manner  the  receipts  of  any  particular  day  are  prop- 
erly deposited  in  the  bank  but  the  credits,  instead  of  being 
entered  in  favor  of  those  making  the  payments,  are 
entered  to  the  credit  of  those  who  paid  on  the  previous 
day  with  the  result  that  the  cash  entries  are  always  at 
least  one  day  behind  the  bank  entries. 

This  system  is  known  as  the  Lapping  System.  In  order 
to  detect  its  use  it  is  only  necessary  to  procure  copies  of 
the  deposit  slips  from  the  bank  and  compare  the  individ- 
ual items  thereon  with  the  entries  in  the  cash  book.  It 
is  manifestly  impossible  for  the  operator  to  do  any  more 
than  keep  the  totals  of  the  deposits  and  the  receipts  alike ; 
the  items  going  to  make  up  the  two,  being  the  cash  or 


210  ACCOUNTING  PRINCIPLES 

check  receipts  of  two  different  days,  must  be  of  different 
amounts  and  a  comparison  should  immediately  disclose 
the  fraud. 

The  advantage  of  making  all  payments  by  check  lies 
in  that  more  than  one  person  can  be  made  responsible 
for  the  payment  and,  if  the  check  is  substantiated  by  a 
properly  prepared  voucher,  the  entire  history  of  the  trans- 
action can  be  easily  traced. 

Petty  Cash. 

Wherever  the  entire  cash  receipts  are  deposited  in  the 
bank  and  all  payments  made  by  check,  it  becomes  neces- 
sary to  arrange  some  plan  for  paying  the  small  petty  bills, 
such  as  car  fare,  express,  etc.,  which  come  in  from  time 
to  time  and  which  are  immediately  payable  or  do  not 
warrant  the  use  of  a  check.  These  are  cared  for  by  ap- 
pointing some  one  as  Petty  Cashier  and  by  providing  that 
person  with  a  fund  from  which  to  make  these  payments. 
As  soon  as  the  fund  is  exhausted,  or  at  any  particular 
time,  the  petty  cashier  is  credited  with  the  amount  of  the 
payments  and  a  new  check  is  issued  to  reimburse  the 
fund. 

Imprest  Cash. 
Revolving  Fund. 

Often  the  Petty  Cash  consists  of  an  account  in  the 
general  books,  operated  as  stated  above,  which  is  charged 
with  the  amount  of  the  checks  issued  in  favor  of  the  Petty 
Cashier  and  credited  with  the  amount  disbursed.  In  this 
case  the  balance  of  the  fund  might  vary  from  time  to 
time.  It  is  preferable,  however,  to  have  a  predetermined 
amount  as  the  basis  of  the  fund  and  to  keep  that  one  item 
on  the  books  as  a  charge  to  the  fund,  only  increasing  or 
decreasing  it  when  it  becomes  desirable  to  reduce  or 


MISCELLANEOUS  SUBSIDIARY  ACCOUNTS  211 

increase  the  amount  of  the  fund.  The  amount  of  the 
fund  should  be  based  on  the  maximum  amount  of  expendi- 
tures for  a  particular  period,  say  a  week  or  a  month,  and 
at  the  end  of  each  of  these  periods  the  Petty  Cashier 
should  prepare  ttn  itemized  list  of  the  expenditures  and 
should  secure  a  check  for  the  exact  amount,  thereby 
bringing  the  fund  up  to  its  original  sum  but  without  dis- 
turbing the  original  charge  to  Petty  Cash  in  the  Ledger. 
At  all  times  the  petty  cashier  should  have  on  hand  money 
or  vouchers  for  disbursements  to  equal  the  amount  of  the 
fund. 

As  an  assistant  to  the  proper  vouching  of  the  petty 
cash,  we  recommend  the  use  of  a  bound  book,  with  alter- 
nate leaves  perforated,  printed  with  columns  for  the  fol- 
lowing information  :  Date,  Total  Disbursements,  Amount 
I'jrd,  Received  by,  For  whom,  Remarks.  The  above  infor- 
mation to  be  filled  in  for  each  payment  and  to  be  recorded 
in  duplicate  by  the  aid  of  carbon.  The  original  copy  on 
the  perforated  sheet  to  be  removed  from  the  book  at  the 
end  of  the  period  and  serve  as  a  voucher  for  the  check 
while  the  carbon  copy  will  serve  as  a  bound  record  for 
the  benefit  of  the  petty  cashier.  The  original  sheet  should 
be  of  the  same  size  as  the  regular  voucher  used  by  the 
firm,  to  facilitate  filing  with  the  others,  and  should  con- 
lain  the  same  information  on  the  back  as  to  distribution 
of  items,  etc. 

As  a  prevention  of  fraud,  the  petty  cashier  should  not 
be  allowed  to  receive  any  money  from  cash  sales,  etc., 
and  should  be  compelled  to  produce  a  receipt  for  every 
disbursement,  no  matter  how  trivial. 

This  manner  of  caring  for  such  payments  is  known 
either  as  the  Imprest  System  or  the  Revolving  Fund 
Svstem. 


212  ACCOUNTING  PRINCIPLES 

Branches* 

In  the  operation  of  branches,  the  only  difference  in  the 
handling  of  the  cash  will  be  that  the  cashier  will  usually 
have  control  of  the  cash  receipts  of  the  branch  as  well  as 
the  Revolving  Fund  and  that  the  Kevolving  Fund  will 
necessarily  have  to  contain  a  larger  amount  than  would 
be  desirable  were  it  possible  to  reimburse  it  on  a  few 
moments  notice. 

The  Cashier  should  not  be  allowed  to  confuse  the  re- 
ceipts with  the  disbursements  and  should  be  compelled  to 
deposit  all  receipts  of  whatever  nature  in  the  bank  to 
the  credit  of  the  Executive  Office  and  in  turn  the  Execu- 
tive Office  should  replenish  the  Revolving  Account  of  the 
Branch  upon  the  receipt  of  proper  vouchers  for  expendi- 
tures. 

• 

Sales. 

The  Sales  Account  is  intended  to  contain  a  complete 
record  of  the  sales  of  the  articles  acquired  or  manufac- 
tured for  that  purpose  and,  in  the  majority  of  concerns, 
no  subsidiary  accounts  are  required.  A  few  concerns, 
handling  a  diversity  of  products,  divide  their  sales  into 
various  sub-accounts,  each  representing  the  class  of 
article  disposed  of ;  but,  except  in  rare  cases,  this  seems  a 
considerable  waste  of  time.  The  principal  desirable 
cases  arise  in  connection  with  concerns  handling,  in  addi- 
tion to  their  own  product,  some  article  on  which  they 
pay  a  royalty  or  which  is  handled  on  a  commission  basis ; 
or  where,  as  in  the  case  of  a  branch  office  handling  a 
number  of  products,  the  percentage  of  profit  on  which 
varies,  it  is  desirable  to  keep  a  check  on  stock  by  applying 
the  actual  profit  on  turnover  in  comparison  with  the  esti- 
mated profit  that  the  goods  should  bring. 


MISCELLANEOUS  SUBSIDIARY  ACCOUNTS  213 

In  order  to  accomplish  this  distribution  of  the  sales, 
extra  columns  are  provided  in  books  of  original  entry  for 
each  class  of  product  or  each  division  determined  upon 
in  addition  to  the  column  containing  the  original  entry, 
then,  as  each  sale  is  recorded,  it  is  analyzed  and  the 
proper  amounts  extended  into  each  of  the  distribution 
columns  to  the  credit  of  the  proper  subsidiary  account. 

Cash  Sales. 

Wherever  it  becomes  desirable  to  separately  record  the 
sales  of  the  various  articles  handled,  some  provision  must 
be  made  for  caring  for  the  sales  made  for  cash.  This  can 
be  accomplished  by  providing  separate  columns  in  the 
Cash  Book  for  each  subdivision,  but,  if  the  Cash  Book 
is  thereby  made  unduly  cumbersome,  only  one  column 
need  be  provided  and  all  cash  sales  can  be  entered  therein, 
ruder  this  plan  the  total  of  the  column  is  to  be  posted 
to  the  credit  of  a  Cash  Sales  Account  in  the  Ledger.  The 
sales,  as  entered  in  the  Cash  Book,  should  be  analyzed 
and  distributed  in  the  Sales  Book  to  the  proper  columns 
and  their  sums  retained  in  a  special  column  headed  "Cash 
Sales,"  the  total  of  which  would  be  posted  to  the  debit 
side  of  the  Cash  Sales  account  in  the  Ledger.  The  charge 
to  this  account  from  the  Sales  Book  should  exactly  equal 
the  Credit  posted  from  the  Cash  Book  and  the  account 
should  balance  from  month  to  month. 

Purchases. 

Wherever  sales  are  apportioned  as  outlined  in  the  pre- 
ceding paragraphs,  it  becomes  necessary  to  provide  like 
accounts  for  the  purchases  and  like  columns  in  books  of 
original  entry,  so  that  the  results  obtained  from  the  sale 
of  each  product  may  be  ascertained.  Cash  Purchases  may 
be  treated  the  same  as  Cash  Sales,  if  desired. 


214  ACCOUNTING  PRINQJPLES 

Inventories. 

Inventories  would,  likewise,  have  to  be  separated  to 
correspond  with  the  sales,  and  should  be  arranged  in 
accordance  with  the  outline  given  in  Chapter  VIII. 

The  principal  other  accounts  that  are  subsidiary  to  it 
are  those  representing  goods  that  have  been  transferred 
to  some  other  person  either  for  that  person  to  sell  or  as 
a  sale  subject  to  approval.  In  neither  case  should  the 
transaction  be  looked  upon  as  a  sale.  No  valid  contract 
of  sale  exists  and  there  is  a  possibility  of  the  goods  being 
returned,  hence  they  should  be  included  in  the  inventory 
the  same  as  other  goods  in  possession.  Often  such  sales 
are  billed  out  at  a  sum  in  excess  of  the  actual  inventory 
value,  in  which  case,  whatever  account  received  credit 
for  the  loading  should  be  adjusted  at  the  time  of  inven- 
tory. 

Goods  with  branches  are  usually  treated  the  same  as 
Consignment  Sales  and  should  likewise  be  reduced  to  in- 
ventory value  at  the  end  of  each  period.  At  the  opening 
of  the  new  period,  whatever  entry  was  made  to  effect  this 
result  may  be  reversed  and  the  original  record  of  the 
transaction  given  effect  again  for  use  during  the  new 
fiscal  year. 


MISCELLANEOUS  SUBSIDIARY  ACCOUNTS  215 

C.  P.  A.  Questions 

1.  What  do  you  consider  the  proper  way  to  handle 
cash  in  accounts?    What  advantages  are  there,  if  any,  in 
banking  each  day  the  exact  receipts  of  the  previous  day? 
(Fla.) 

2.  Describe  a  desirable  system  of  keeping  a  petty 
CM  si  i  book  and  petty  cash  vouchers?     (N.  Y.) 

3.  Explain  the  uses  and  relations  of  the  petty  cash 
book  to  the  principal  cash  book.     (N.  Y.) 

4.  You  have  in  hand  the  examination  of  the  cash 
and  bank  account  of  a  mercantile  firm  that  uses  checks 
very  freely.    Draft  a  reconcilement  account,  bringing  the 
cash  book  and  bank  pass  book  into  harmony  at  the  close 
of  the  period  under  review.     (N.  Y.) 

.").  In  closing  the  books,  how  would  you  value  goods 
owned  by  your  client  and  consigned  at  selling  price  to 
customers  of  your  client,  under  an  agreement  by  which 
the  customers  pay  for  the  goods  as  used?  Give  reasons. 
(N.  Y.) 

(i.  An  auditor  for  a  manufacturing  company  is  con- 
fronted with  three  conditions,  viz.:  (a)  goods  shipped 
"on  consignment"  and  remaining  unsold;  (b)  goods 
shipped  to  customers  on  "sale  or  return,"  and  remaining 
unsold;  (c)  goods  on  hand  at  agencies.  How  should 
these  accounts  be  valued  and  placed  in  the  balance  sheet? 
(N.  Y.) 

7.  Rule  and  title  five  columns  of  a  petty  cash  book 
in  addition  to  the  discription  columns  and  make  an  illus- 
trative entry  for  and  in  each  distribution  column.  (N.  Y.) 

8.  A  house  sends  out  many  goods  on  approval  and 
treats  the  transactions  as  sales.    How  should  such  items 
be  treated  by  the  auditor  when  setting  up  statements  for 
a  period?     (N.  Y.) 


CHAPTER  XX 

Miscellaneous  Collective  Accounts 

A  Collective  Account  differs  from  other  accounts  to  the 
extent  that  each  item  contained  therein  retains  its  identity 
throughout  its  life;  whereas  other  classes  of  accounts 
absorb  the  items  that  enter  into  them. 

The  object  of  Collective  Accounts  is  to  consolidate  a 
number  of  accounts  of  a  class  for  statistical  purposes 
or  for  condensing  information  without  affecting  the  indi- 
viduality of  the  accounts  proper. 

The  record  of  the  various  transactions  must  be  such 
that  it  will  display  the  effect,  not  only  on  the  individual 
accounts,  but  on  the  collective  account  as  well. 

Bills  Receivable. 

Their  most  simple  form  is  that  of  the  Bills  Receivable 
Account,  which  is  intended  to  contain  an  itemized  record 
of  all  the  notes  received.  Each  note,  although  included 
in  the  account  with  the  others,  must  be  treated  individu- 
ally and  when  it  is  paid  must  be  cancelled  from  the  ac- 
count. 

Bills  Receivable  Ledger. 

If  there  are  such  a  great  number  of  notes  that  it  would 
be  impracticable  or  confusing  to  attempt  to  keep  an  in- 
dividual record  of  each  note  in  the  usual  manner,  an 
auxiliary  record  could  be  kept;  this  would  allow  greater 
latitude  in  arranging  the  accounts  and  would  assist  in 
retaining  their  identity.  Should  such  a  record  be  main- 
tained, it  would  not  be  necessary  for  the  Bills  Receivable 
Account  in  the  ledger  to  contain  such  a  complete  record 


MISCELLANEOUS  COLLECTIVE  ACCOUNTS  217 

as  heretofore  and,  instead  of  the  individual  record  of  each 
note,  it  would  contain  only  the  totals  of  the  items  going 
to  make  up  the  subsidiary  record. 

In  order  to  secure  these  totals  and  to  eliminate  the 
mass  of  detail  in  the  original  account,  all  books  of  origi- 
nal entry  that  are  to  contain  items  affecting  this  account 
should  be  provided  with  a  separate  column  for  this  class 
of  items  and  the  total  of  the  class  should  be  posted  to  the 
original  account  while  the  individual  items,  going  to  make 
up  this  total,  should  be  posted  to  the  subsidiary  record; 
or  if  desired,  the  original  record  of  the  notes  received  may 
also  become  their  final  record.  This  could  be  accomp- 
lished by  recording  the  notes  in  detail,  in  the  order  of 
their  occurrence,  posting  their  total  to  the  debit  of  the 
Bills  Receivable  Account  in  the  General  Ledger  and  the 
amount  of  each  note  to  the  credit  of  each  personal  ac- 
count atf'ected  thereby.  This  original  record  would  then 
represent  the  debit  side  of  the  Bills  Receivable  Account; 
but  the  Bills  Receivable  Account  in  the  general  books, 
instead  of  showing  the  individual  items,  would  only  show 
the  totals,  while  the  subsidiary  record  would  contain  the 
details.  As  the  notes  are  paid,  individual  items  would 
receive  credit  in  the  subsidiary  record  and  the  total  of 
the  credits  as  determined  from  the  book  of  original  entry 
would  be  posted  to  the  credit  of  the  Bills  Receivable 
Account  in  the  General  Ledger. 

Sundry  Debtors. 

Similar  treatment  may  be  accorded  the  accounts  of 
persons  whose  business  with  the  firm  is  limited  to  the 
extent  that  an  entire  account  is  not  required  to  contain 
the  record  of  their  transactions.  In  connection  with 
loose  leaf  ledgers,  the  major  portion  of  the  accounts  are 
usually  alloted  an  entire  page,  and  these  are  filed  in  the 


218  ACCOUNTING  PRINCIPLES 

binder  in  alphabetical  order,  but  certain  of  them  do  not 
require  such  a  great  amount  of  space  and,  in  order  to 
accommodate  these,  a  separate  sheet  intended  to  contain 
a  number  of  accounts  is  inserted  after  each  index. 

Sundry  Debtors'  Ledger. 

A  similar  record,  but  in  book  form,  is  also  used  at 
times  in  connection  with  businesses  having  numerous 
small  accounts  with  customers  who  only  deal  with  the 
firm  once  or  twice  a  year.  It  usually  contains  debit 
columns  the  same  as  the  debit  side  of  a  ledger,  but 
as  payments  may  extend  over  a  number  of  months  and 
as  the  total  credits  to  the  book  each  month  might  be 
required  in  balancing,  a  number  of  credit  columns  would 
be  provided,  one  for  each  month  in  which  credits  might 
be  applied. 

The  last  column  on  the  credit  side  should  be  reserved 
for  extending  all  items  that  are  not  paid  in  the  time  pro- 
vided for  by  the  special  columns.  This  allows  for  the 
balancing  of  each  page,  and  the  unpaid  items  can  be  car- 
ried forward.  There  is  no  necessity  of  providing  for  the 
segregation  of  the  charges  into  months  as  they  would  be 
entered  in  the  order  of  their  occurrence  and  a  new  ac- 
count could  be  provided  for  the  new  customers  of  each 
succeeding  month. 

The  plan  outlined  above  automatically  forms  itself 
into  a  series  of  accounts  each  one  representing  the  bal- 
ances carried  forward  at  the  beginning  of  a  month  and 
also  the  charges  for  that  month;  a  new  account  being 
formed  each  month  from  the  unpaid  balances  carried 
forward  from  the  oldest  account  on  the  books.  The 
life  of  an  account  would  be  governed  by  the  number  of 
columns  provided  and,  as  a  new  account  would  be  opened 
each  month,  there  would  be  as  many  live  accounts  as  there 


MISCELLANEOUS  COLLECTIVE  ACCOUNTS  219 

were  months  allotted  to  each,  but  each  account  would  be 
just  one  month  older  than  the  succeeding  one. 

There  is  always  a  possibility  that  a  customer  may 
make  more  purchases  than  was  anticipated  and  wherever 
such  a  ledger  is  used  it  becomes  necessary  to  provide  some 
plan  by  which  the  various  purchases  may  be  readily  con- 
nected. It  is  usually  not  desirable  to  attempt  to  insert 
additional  purchases  in  the  lines  originally  allotted  to 
the  account,  as  this  has  a  tendency  to  disturb  the  totals 
of  the  pages,  but  there  is  no  objection  to  including,  at  the 
end  of  each  monthly  account,  the  purchases  that  have  been 
iiuide  by  the  persons  whose  accounts  are  represented 
therein ;  then,  in  order  to  call  attention  to  the  existence 
of  an  additional  purchase,  the  accounts  should  be  cross 
indexed.  The  best  plan  of  cross  indexing  seems  to  be  to 
use  a  combination  of  the  last  figures  appearing  in  the  folio 
numbers  and  to  place  these  just  before  each  account 
shown.  Should  greater  individuality  of  cross  indexing  be 
desired,  arbitrary  letters  may  be  used  in  connection  with 
the  figures  to  designate  certain  accounts. 

As  an  example,  John  Jones'  account  appears  on  page 
660,  on  the  tenth  of  the  succeeding  month  he  makes  an 
other  purchase  which  is  recorded,  at  the  end  of  the  ac- 
count containing  his  original  purchase,  on  page  664. 
We  wish  to  cross  index  them  and,  presuming  there  is 
already  an  account  indexed  "04,"  we  will  index  these 
"A04." 

The  plan  of  using  the  ledger  as  a  book  of  original  entry 
as  outlined  under  Bills  Receivable  is  used  to  good  advan- 
tage in  connection  with  sundry  debtors  in  such  lines  of 
business  as  Telephone  Companies,  etc.,  which  have  a 
regular  recurring  charge  against  each  account  each 
month.  The  number  of  postings  is  greatly  reduced  if  the 
one  record  can  be  used  both  as  the  original  and  the  final 


220  ACCOUNTING  PRINCIPLES 

book  entry.  In  fact,  though,  in  the  majority  of  cases  in 
modern  accounting,  some  record  on  charge  slips,  meter 
reading  reports,  etc.,  is  the  actual  original  and  the  books 
invariably  refer  to  them. 

Controlling  Account. 

Wherever  a  subsidiary  record  is  kept  there  must  be 
some  account  in  the  General  Ledger  to  contain  a  synopsis 
of  the  items  in  that  record.  Such  an  account  is  consid- 
ered as  controlling  the  subsidiary  record  and  is  known 
as  the  Controlling  Account. 

Adjustment  Account. 

If  the  condition  of  affairs  is  such  that  the  persons 
keeping  the  subsidiary  record  do  not  have  access  to  the 
controlling  account,  either  because  the  records  are  kept 
in  different  offices  or  cities  or  because  it  is  not  desired 
that  the  various  bookkeepers  refer  to  the  General  Ledger, 
they  can  make  the  subsidiary  record  self  balancing  by 
setting  up  an  adjustment  account  in  their  ledger  to  con- 
tain the  complement  of  all  entries  that  enter  therein. 
This  adjustment  account  would  contain  the  same  items 
that  are  in  the  Controlling  Account  in  the  General  Book? 
but  would  show  them  on  opposite  sides. 

To  illustrate:  The  debit  entries  to  the  various  ac- 
counts in  the  subsidiary  ledger  would  appear,  in  total, 
as  the  debit  of  the  account  representing  them  in  the 
General  Ledger,  but,  to  the  credit  of  the  account  that  is 
set  up  in  the  subsidiary  ledger  to  counterbalance  them ; 
hence  the  adjustment  account  must  be  the  complement 
of  the  controlling  account. 

The  advantage  of  such  accounts  lies  in  that  the  work 
may  be  apportioned  over  a  considerable  number  of  book- 
keepers, each  of  which  will  be  able  to  prove  his  own  work 
without  disturbing  the  other  and  without  affecting  the 


MISCELLANEOUS  COLLECTIVE  ACCOUNTS  221 

controlling  records,  and  that  the  general  books  will  con- 
tain all  the  required  information  about  the  accounts 
contained  in  a  subsidiary  record,  without  the  mass  of  de- 
tail, thereby  enabling  the  easy  preparation  of  financial 
statements. 

Too  much  stress  should  not  be  laid  upon  the  accuracy 
of  the  Controlling  Account  for,  if  the  records  going  to 
make  up  the  totals  are  incorrectly  added,  both  the  con- 
trolling account  and  the  account  that  received  the  other 
portion  of  the  entry  will  have  received  the  incorrect  sum 
without  throwing  the  General  Ledger  out  of  balance. 

Subscription  Account. 

The  Subscription  Account  is  another  form  of  Collect- 
ive Account. 

It  is  usually  undesirable  to  fill  up  the  general  books 
with  accounts  with  persons  who  have  subscribed  for  the 
stock  of  the  corporation  and,  in  lieu  of  so  doing,  an 
auxiliary  record  of  these  accounts  is  kept;  the  total  only 
appearing  in  the  general  books  under  the  heading  Sub- 
scription Account. 

Capital  Stock  Account 
Stock  Ledger. 

The  Capital  Stock  Account  is  also  a  Collective  Ac- 
count and  is  usually  cared  for  in  the  same  subsidiary 
ledger  by  the  use  of  Combined  Accounts  as  outlined  in 
Chapter  IV,  but  in  this  case  the  quantity  of  shares  will 
control  instead  of  their  par  value  hence  plain  ruled  col- 
umns should  be  substituted  for  those  used  where  money 
is  to  be  recorded. 

At  the  time  stock  is  subscribed,  an  entry  is  made  in 
the  general  books  debiting  Subscription  and  crediting 
Capital  Stock,  therefore,  in  the  subsidiary  books  we  must 
debit  each  subscriber  with  the  amount  of  his  subscrip- 


222  ACCOUNTING  PRINCIPLES 

tion  and  credit  him  with  the  quantity  of  stock  that  rep- 
resents his  interest. 

In  order  to  keep  this  ledger  in  balance,  Adjustment 
Accounts  should  be  opened  with  Capital  Stock  (shares) 
and  Subscription  (dollars)  and  should  be  arranged  so 
they  will  be  the  complement  of  their  Controlling  Ac- 
counts in  the  other  ledger. 

Such  a  ledger  would  be  provided  with  columns  to 
contain  the  following  information : 

Debit :    Date ;  Certificate  Number ;  Disposition  ; 

Shares,  quantity;  Subscription  Liability. 

Credit:  Date;  Certificate  Number;  How  Acquired; 

Shares,  quantity;  Subscription  Paid. 

• 
The  amounts  entered    in    the    Adjustment  Accounts 

should  be  entered  in  columns  to  correspond  with  the 
entries  in  the  Personal  Accounts  and  should  allow  the 
balancing  of  each  set  of  accounts  separately,  i.  e.,  the 
items  entered  in  the  Shares  Column,  debit,  should  equal 
those  entered  in  the  credit  column,  and  the  amounts 
entered  in  the  Subscription  Column,  debit,  should  equal 
the  credits  entered. 

Dividends  Payable  Account. 

It  is  unnecessary  to  include  in  the  general  books,  ac- 
counts with  each  of  the  stockholders  at  the  time  dividends 
are  declared.  Instead  the  amount  of  the  dividend  is 
credited  to  Dividends  Payable  Account  and  as  the  divi- 
dends are  paid  this  account  is  charged,  a  subsidiary 
record  being  kept  to  contain  the  detailed  information 
and  accounts. 

Expense  Account. 
Expense  Ledger. 

The  tendency  of  modern  accounting  is  to  carefully 
apportion  all  items  of  expense.  This  usually  requires  a 


MISCELLANEOUS  COLLECTIVE  ACCOUNTS  223 

considerable  number  of  distribution  columns  in  the  books 
of  original  entry,  often  making  them  very  cumbersome, 
but  if  desired,  relief  can  be  obtained  by  extending  all 
items  of  expense  into  one  column  and  then  analyzing  and 
distributing  the  items  in  a  separate  book  provided  with 
the  columns  for  each  sub-division. 

The  total  of  the  entries  in  the  subsidiary  record  must 
equal  the  total  entries  in  the  expense  column  for  a  like 
jMM-iod  and  will  take  its  place  in  any  financial  state- 
ments that  are  prepared,  or  in  the  books,  if  desired. 

Salary  Account. 
Salaries  Ledger. 

In  many  concerns,  it  is  undesirable  that  the  office 
employees  know  the  salary  each  is  getting.  If  the  in- 
formation is  recorded  openly  in  the  cash  book,  they  will 
undoubtedly  devise  some  plan  to  secure  it.  It  is  also  some- 
tiiiM's  desirable  to  distribute  the  salaries  over  a  number 
of  departments.  In  either  case  a  Salaries  Ledger,  oper- 
ated on  the  principle  of  the  Expense  Ledger,  could  be  used 
to  contain  this  information  and,  if  it  were  important  that 
this  information  should  not  be  disclosed,  a  lock  ledger 
could  be  used,  in  which  case  only  those  possessing  a  key 
could  inspect  it. 

Materials  Account. 
Stores  Ledger. 

In  connection  with  cost  accounts,  it  is  important  that 
a  careful  record  be  kept  of  all  stores  on  hand.  This  is 
accomplished  by  keeping  a  complete  record  of  each  article 
in  stock;  the  Materials  Account  in  the  General  Ledger 
acting  as  a  controlling  account.  Every  item  that  is  pur- 
chased must  be  charged  to  the  Materials  Account  in  the 
general  books  and  likewise  to  the  account  representing 
that  article  in  the  Stores  Ledger. 


224  ACCOUNTING  PRINCIPLES 

As  they  are  used,  this  account  is  credited  and  likewise 
the  Material  Account  in  the  General  Ledger.  The  credits 
to  the  General  Ledger  Account  being  in  totals  only.  At 
the  end  of  any  period  the  value  of  the  stock  on  hand  may 
be  ascertained  by  referring  to  the  Materials  Account 
while  the  quantity  of  each  article  is  always  disclosed  by 
the  stores  record. 

Accounts  Receivable. 
Sales  Ledger. 

The  principal  use  of  Controlling  and  Adjusting  Ac- 
counts lies  in  connection  with  recording  and  separating 
the  accounts  representing  the  sales  to  customers.  These 
are  usually  recorded  in  a  separate  book,  but,  if  the  busi- 
ness is  exceptionally  large,  many  ledgers  may  be  used, 
each  containing  certain  subdivisions  of  the  accounts. 
Each  ledger  should  contain  an  Adjustment  Account  to 
make  it  self-balancing  and  the  general  ledger  should  have 
a  separate  controlling  account  for  each  one.  Such  a  plan 
necessitates  that  all  books  be  provided  with  distribution 
columns  into  which  the  accounts  affecting  each  ledger 
may  be  segregated.  The  following  are  good  examples  of 
sub-divisions : 

Alphabetical :  UA  to  E,"  "F  to  I,"  etc., 

Districts :  City,  Country,  or 

City,  Wash. ;  Ore. ;  Ida. ;  B.  C. 
Salesmen's  territories :    Brown's  Ledger, 

Hill's  Ledger,  etc. 

Numerical  or  decimal  (usually  used  with  cards,  giving 
each  account  a  number ;  the  individual  figures  of  which 
might  represent  territories,  salesmen,  etc.,  in  addition 
to  the  actual  account  number.) 


MISCELLANEOUS  COLLECTIVE  ACCOUNTS  225 

Accounts  Payable. 
Purchase  Ledger. 

A  Purchase  Ledger  may  be  operated  on  the  same  plan 
as  the  Sales  Ledger,  but  to  contain  the  accounts  with 
creditors.  It  is  usually  not  required  to  keep  a  great  num- 
ber of  such  ledgers  but  such  a  plan  could  be  evolved  if 
necessary.  The  most  common  subdivisions  are  City  Pur- 
chases and  Out  of  Town  or  Country  Purchases. 

Plant  Account. 
Plant  Ledger. 

A  Plant  or  Equipment  Ledger  is  often  operated 
auxiliary  to  the  Machinery  or  Plant  Account,  and,  in 
general,  also  the  Reserve  for  Depreciation  and  Reserve  for 
Renewal  Accounts.  Such  a  ledger  is  controlled  by  the 
above  mentioned  accounts  and  contains  the  history  of 
every  article  included  therein,  with  the  provision  that 
has  been  made  for  depreciation,  repairs  and  renewals. 
It  serves  as  a  basis  for  determining  the  advisability  of 
purchasing  certain  similar  articles  in  the  future  and  also 
of  adjusting  the  controlling  accounts  or  the  rate  of  de- 
preciation at  the  time  an  article  is  sold  or  appraised. 

One  of  its  principal  advantages  is  that  the  depreciation 
and  the  repairs  or  renewals  on  each  article  may  be  treated 
independently  without  affecting  the  other  articles  included 
in  the  plant  account. 

Investment  Account. 
Investment  Ledger. 

Wherever  a  concern  makes  extensive  investments  in 
bonds,  etc.,  it  becomes  desirable  to  isolate  such  accounts 
from  the  general  books.  A  separate  ledger  can  be  easily 
adapted  to  this  purpose  and  can  contain  accounts  with 
each  security  purchased  and  its  accretions  without  unduly 


226  ACCOUNTING  PRINCIPLES 

affecting  the  general  books.  If  desired,  a  separate  journal 
could  be  used  to  record  the  results,  in  which  case  it  would 
only  be  necessary  to  reconcile  the  Adjustment  Account 
and  the  Controlling  Account  at  the  end  of  each  fiscal 
period.  The  combined  account  form  is  most  desirable  for 
use  in  this  connection. 

Suspense  Account. 
Suspense  Ledger. 

It  is  very  undesirable  to  cancel  a  customer's  indebted- 
ness from  the  ledger  for,  possibly,  at  some  future  date  the 
customer  may  become  able  to  pay,  in  which  case,  even 
though  the  account  be  "outlawed"  it  is  often  possible  to 
have  him  to  do  so;  neither  is  it  desirable  to  load  up  the 
active  ledgers  with  these  dead  accounts.  The  better  plan 
is  to  transfer  the  account,  bodily  if  loose  leaf  ledgers  are 
used,  to  a  Suspense  Ledger,  where  it  can  receive  such 
attention  as  it  is  possible  to  give  it.  Needless  to  say,  the 
Controlling  and  Adjustment  Accounts  of  both  Ledgers 
should  be  adjusted  to  give  effect  to  the  transfer. 

Accounts  representing  notes,  over  due  and  uncollect- 
able,  may  be  treated  in  the  same  manner,  but  as  a  pre- 
caution against  the  loss  of  the  notes  they  should  be  affixed 
to  the  account  leaf  in  the  Suspense  Ledger. 

Private  Ledger. 

In  connection  with  the  general  books  of  many  concerns 
there  is  much  information  which  it  is  desirable  to  keep 
private.  This  is  particularly  true  of  that  contained  in 
accounts  referring  to  the  capitalization,  owners,  inven- 
tories, fixed  indebtedness,  investments,  etc.  The  number 
of  entries  affecting  such  accounts  are,  necessarily,  very 
small  and  if  the  accounts  were  removed  they  could  easily 
be  kept  by  the  firm's  consulting  accountant,  while  their 
isolation  from  the  more  active  accounts  would  effect- 


MISCELLANEOUS  COLLECTIVE  ACCOUNTS  227 

ually  debar  any  of  the  employees  from  learning  the  con- 
dilion  of  the  linn. 

In  order  to  accomplish  such  a  result,  the  general 
ledger  would  contain  only  such  accounts  as  are  built  up 
from  day  to  day  in  the  regular  course  of  business  and  also 
an  adjustment  account  with  the  private  ledger,  to  keep 
the  general  ledger  in  balance.  It  would  have,  as  before, 
numerous  subsidiary  ledgers  but,  in  turn,  would  be  sub- 
sidiary to  the  Private  Ledger. 

The  Private  Ledger  would  contain  in  detail  all  of  the 
accounts  that  were  not  included  in  the  General  Ledger 
and  also  a  Controlling  Account  representing  those  ac- 
counts remaining  open  in  the  General  Ledger,  at  the  time 
of  the  last  closing,  as  well  as  the  transfers  that  have  been 
made  between  the  two  books  in  the  meanwhile. 

In  closing  the  books  at  the  end  of  each  period,  it  be- 
comes necessary  to,  in  effect,  close  all  of  the  accounts  of 
the  General  Ledger  into  the  Private  Ledger,  but,  as  in  fact, 
many  of  the  accounts  are  immediately  returned  to  the 
General  Ledger,  it  is  only  actually  necessary  to  transfer 
the  totals  of  certain  of  the  revenue  accounts  to  that 
ledger.  The  adjusting  entries  are  made  in  the  private 
books  to  close  and  adjust  the  accounts  and  to  open  them 
again. 

Auxiliary  to  the  Private  Ledger,  it  is  desirable  to  oper- 
ate a  Private  Cash  Journal,  which,  if  it  is  of  sufficient 
detail,  might  provide  for  all  the  accounts  represented  and 
could  entirely  supplant  the  ledger. 


228  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  Show  the  manner  in  which  controlling  accounts 
are  employed  in  commercial  and  municipal  bookkeeping. 

(N.  Y.) 

2.  Does  any  advantage  attach  to  the  employment  of 
more  than  one  volume  for  the  ledger  of  a  business  requir- 
ing only  one  bookkeeper?    Give  reasons.     (N.  Y.) 

3.  Describe   a   system   of   bookkeeping   wherein   the 
errors  may  be  localized.     (N.  Y.) 

4.  What  are  Controlling  Accounts?     For  what  pur- 
pose are  they  employed  and  how  are  they  conducted? 
(Va.) 

5.  What   do  you   consider   the   best   subdivision    of 
ledgers,  when  sales  amount  to  $6,000,000  to  110,000.000 
per  annum  in  a  manufacturing  business,  say  steel?    De- 
scribe fully,  your  plan  or  method  of  connecting  up  the 
ledgers  employed,  also  the  method  of  treating  purchases 
and  sales.     (Penn.) 

6.  What  do  you  understand  by  a  self  balancing  pur- 
chase ledger?     Describe  fully  the  method  of  keeping  it. 
(K.  I.) 

7.  Describe  a  way  of  keeping  a  Bills  Receivable  Book 
as  a  book  of  original  entry  from  which  the  credits  to  per- 
sonal accounts  are  posted  in  detail  while  only  the  total 
of  monthly  charges  and  liquidation  of  notes  are  posted 
to  the  bills  receivable  account.     (N.  Y.) 

8.  In  auditing  the  accounts  of  a  firm,  you  find  a  num- 
ber of  dishonored  and  overdue  notes  which  form  part  of 


MISCELLANEOUS  COLLECTIVE  ACCOUNTS  229 

the  balance  of  bills  receivable  account.    State  fully  what 
you  would  do  with  these.     (Penn.) 

9.  A  manufacturer  makes  extensive  investments  in 
stocks  and  bonds,  buying  and  selling  from  time  to  time 
as  the  market  conditions  warrant  and  clearing  all  such 
transactions  through  his  regular  books  of  account.    How 
could  such  transactions  be  isolated  from  his  manufactur- 
ing operations  and  what  books  and  accounts  should  he 
employ  to  record  the  details  of  the  principal  and  income 
from  such  investments?     (N.  Y.) 

10.  Explain  the  purpose  and  manner  of  keeping  a 
private  ledger  as  part  of  the  financial  books  of  a  firm 
or  corporation.    (N.  Y.) 

11.  On  January  1,  1912,  a  firm  possessed  the  follow- 
ing assets: 

Buildings $3,000.00 

Plant  and  Machinery 2,000.00 

Inventory  Mdse 2,000.00 

Accounts  Receivable: 

Smith $400.00 

Jones 500.00 

Brown 200.00 

White 400.00 

Stone 100.00 

Roberts 600.00 

Allen 200.00 

Dick 600.00 

Currie 200.00 

Johnston 200.00 

3,400.00 
Cash.  600.00 


$11,000.00 


230 


ACCOUNTING  PRINCIPLES 


The  creditors  were  made  up  as  follows: 

Long $550.00 


Thin  

550  00 

Black       

600  00 

Kay 

300  00 

Low     .          .... 

900  00 

Robb  

1,100  00 

$4,000.00 

The  Capital  of  the  firm  belonged  in  equal  shares  to 
Peat  and  Smart. 

During  the  month  of  January  the  following  transac- 
tions occurred: 


Sales 

Smith $100.00 

Jones 150.00 

Brown 200.00 

White 50.00 

Stone 200.00 

Roberts 300.00 

Allen 150.00 

Dick..  200.00 


Cash  Received 
Smith..  $500.00 


Jones.  . 
Brown . 
White.. 
Stone. . 
Allen.  . 
Dick.. 


500.00 
300.00 
300.00 
150.00 
300.00 
750.00 


$1,350.00 
Purchases 

Long $500.00 

Thin 300.00 

Black 500.00 

Kay 400.00 

Low 200.00 

Robb..  200.00 


$2,800.00 
Cash  Payments 
General  Expense  .     $500 . 00 

Peat 200.00 

Smart 200.00 

Long $550.00 

Thin..      .   550.00 


Black 
Kay. 
Low. 
Robb. 


200.00 
300.00 
500.00 
400.00 


$2,100.00 


2,500.00 
$3,400.00 


MISCELLANEOUS  COLLECTIVE  ACCOUNTS  231 

Record  these  transactions  in  a  Sales  Ledger,  Purchase 
Ledger  and  General  Ledger,  making  each  self  balancing. 
Take  off  a  Trial  Balance  from  each  Ledger  and  close  the 
books  as  on  January  31,  1912.  Inventory  at  that  date  was 
$3,000.00.  Reserve,  $200.00  for  Outstanding  Expense,  and 
$100.00  for  possible  loss  from  Bad  Debts  before  closing. 

12.  Explain  how  you  would  install  for  a  large  con- 
cern, a  system  of  bookkeeping  arranged  so  that  only  the 
proprietor  or  officers  of  the  company,  together  with  their 
auditor,  a  Certified  Public  Accountant,  shall  be  cognizant 
of  its  financial  condition  and  annual  profits  or  losses. 

(in.) 

13.  In  closing  the  books  of  a  firm,  it  is  found  that 
the   accounts   receivable   include   $5,000.00   of   worthless 
accounts  and  $10,000.00  of  doubtful  accounts.     The  firm 
decides  to  deduct  from  the  gross  profits  $15,000.00  for 
these  items.     What  would  you  consider  the  best  method 
of  carrying  these  items  on  the  General  Ledger?     (N.  Y.) 

14.  Describe  fully  the  operation  of  the  controlling 
account  expedient  as  used  in  connection  with  a  private 
ledger.     (N.  Y.) 

15.  State  fully  how  the  disbursements  entered  in  a 
petty  cash  book  should  be  carried  to  the  controlling  ac- 
count of  expenses  in  the  general  ledger  and  to  the  detail 
accounts  in  the  expense  ledger.     (N.  Y.) 

16.  What  books  of  a  mercantile  firm  should  be  treated 
as  books  of  original  entry  and  be  posted  direct  to  the 
ledger?    Give  an  example  of  an  entry  that  should  neces- 
sarily be  made  in  the  journal.     (N.  Y.) 

17.  What  accounts  should  be  embodied  in  the  pri- 
vate ledger  to  make  it  a  complete  synopsis  of  the  business? 


232  ACCOUNTING  PRINCIPLES 

How  would  you  prove  the  correctness  of  the  accounts? 
(N.  Y.) 

18.  Describe  several  economies  in  accounting  made 
possible  by  the  introduction  of  special  columns  in  books 
of  original  entry.  (N.  Y.) 

20.  In  designing  a  set  of  accounts  for  a  business,  how 
might  provision  be  made  for  a  constant  showing  of  the 
aggregate  sum  owing  by  customers  and  the  aggregate  sum 
owing  to  creditors,  without  the  necessity  of  preparing  a 
schedule  of  the  accounts  of  such  customers  and  creditors  ? 
(N.  Y.) 

21.  Give  several  methods  of  keeping  the  records  of 
petty  accounts  and  accounts  with  infrequent  customers. 

(N.  Y.) 


CHAPTER  XXI 

Trial  Balance 

A  Trial  Balance  is  another  form  of  Collective  Account. 
It  consists  of  a  record  of  the  status  of  each  account,  pre- 
pared for  the  purpose  of  determining  the  correctness  of 
the  amounts  posted  to  a  ledger. 

Its  use  is  based  on  the  fact,  that,  in  double  entry  books 
there  must  be  a  like  amount  of  debits  and  credits.  It  is 
only  used  to  test  the  accuracy  of  the  postings  and  is  not 
even  presumed  to  be  conclusive  proof  that  they  are  cor- 
rect. It  is  the  absolute  certainty  that  there  is  an  error 
somewhere  when  its  sides  do  not  agree  that  makes  a  trial 
balance  valuable.  It  is  sometimes  looked  upon  as  very 
valuable  by  office  managers,  etc.,  in  determining  the 
status  of  the  business,  but  as  it  only  shows  the  balances 
of  the  accounts,  without  special  reference  to  their  value 
or  relation  to  other  accounts  and  without  giving  effect  to 
the  various  accrued  or  deferred  items,  the  information 
they  derive  must  be  very  slight. 

The  principal  errors  that  are  not  located,  through  the 
agency  of  a  trial  balance,  are  errors  of  posting  to  the 
wrong  account  or  incorrect  postings  that  are  counter- 
balanced by  other  inaccuracies.  These  are  of  such  rare 
occurrence  that  the  usual  bookkeeper  is  satisfied  that  his 
work  is  accurate  if  he  is  able  to  secure  a  balance." 

The  method  of  balancing  is  to  prepare  a  synopsis  of  the 
accounts  in  a  ledger  and  then  to  make  the  totals  of  the 
debits  and  credits  agree. 


234  ACCOUNTING  PRINCIPLES 

The  synopsis  taken  may  be  a  list  of  the  footings  of 
each  side  of  every  account,  a  record  of  the  balances  re- 
maining, or  a  summary  of  the  debit  and  credit  postings 
to  each  account  each  month. 

Proof  by  Footings. 

The  most  popular  method  of  taking  a  trial  balance  is 
by  the  aid  of  footings.  It  has  an  advantage  over  the  other 
methods  in  that  it  is  the  simplest  to  draw  off  and  also 
as  the  possibility  of  making  an  error  in  determining 
the  balance  of  the  account  is  eliminated.  By  this  method 
it  is  possible  to  ascertain  upon  which  side  the  error  lies 
and  the  amount  thereof.  To  accomplish  this  result  a 
record  is  retained  of  the  totals  of  the  accounts  outstand- 
ing at  the  first  of  each  month ;  to  their  sum  is  added  the 
totals  of  all  books  of  original  entry  then,  provided  no  ac- 
counts have  been  ruled  up  during  the  month,  the  total  of 
the  footings  of  accounts  in  the  ledger  must  equal  the 
total  of  the  original  balances  and  the  entries  that  have 
been  posted  during  the  period  under  review.  Where  this 
plan  of  proving  is  to  be  used,  it  is  better  not  to  rule  up 
any  accounts  except  just  after  balancing  the  ledger,  then 
the  total  of  those  ruled  may  be  deducted  from  the  origi- 
nal total  to  secure  the  beginning  total  for  the  succeeding 
month. 

Proof  by  Balances. 

The  proof  by  balances  offers  a  slight  advantage  for, 
as  soon  as  the  books  are  in  balance,  the  Trial  Balance 
contains  proper  footings  for  use  in  drawing  up  any  finan- 
cial statements  that  may  be  required,  whereas  the  other 
form  of  Trial  Balance  will  require  reducing  to  balances 
before  the  figures  can  be  used. 


TRIAL    BALANCE  235 

Proof  by  Charges  and  Credits. 

This  method  of  proving,  while  it  involves  considerably 
more  labor  in  drawing  off  the  balance,  is  undoubtedly  the 
easiest  to  prove  and  is  to  be  recommended  wherever  the 
bookkeepers  lack  experience  or  accuracy  in  their  work, 
as  the  additions,  balances,  etc.,  automatically  prove  them- 
selves on  each  page. 

In  order  to  make  each  page  self  balancing  the  trial 
balance  „  should  contain  not  only  the  charges  and  the 
credits  for  the  month,  but  also  the  balances  at  both  the 
beginning  and  end  of  the  period  under  review.  It  would 
appear  as  follows: 


Proof 


Pa^ 

Fol 

40 
50 
60 
61 
64 
66 

pi: 

io     NAME 
Purchases  

Beginning 

Current 
entries 

Ending 

Dr. 

..   500 

Cr. 

800 

2400 

Dr. 

200 
40 
100 
47 
550 

Cr. 

10 
740 

247 

Dr. 

690 

900 
347 
703 

Cr. 
1500 

2400 

Sales  

Plant 

800 

Expense 

300 

Cash  . 

400 

Proprietorship  .... 

2000 

3200 

937 

997 

2640 

3900 

6837 


Pages  2-12 : 

Sundry  Accounts....     1200  740      680    1260 


3200  1677  3900    8777 

3200  1677    3900  8777 


As  a  proof  that  the  additions  have  been  correctly 
made  on  each  page,  columns  one,  three  and  six  must  equal 
columns  two,  four  and  five.  If  an  incorrect  balance  has 
been  entered ;  if  it  has  been  placed  on  the  wrong  side ;  or, 
if  nn  error  has  been  made  in  addition,  the  above  proof 
will  disclose  it. 

If,  after  the  above  items  are  proven,  the  column  totals 


236  ACCOUNTING  PRINCIPLES 

are  not  in  balance,  it  is  undoubtedly  due  to  certain  errors 
existing  in  the  figures  used,  and  it  becomes  necessary  to 
take  each  column  separately  to  localize  the  error. 

Columns  one  and  two  are  easily  verified  by  reference 
to  the  preceding  trial  balance.  Column  three  must  equal 
the  total  debits  as  disclosed  by  adding  the  various  books 
of  original  entry;  the  difference  existing,  if  any,  repre- 
sents the  amount  of  the  error  on  the  debit  side  and,  this 
being  known,  it  is  usually  an  easy  matter  to  pick  it  out. 
The  same  rule  applies  to  proving  the  fourth  column. 
After  columns  one,  two,  three  and  four  have  been  proven, 
numbers  five  and  six  are  an  easy  matter  as  the  errors 
therein  can  only  be  those  that  are  the  result  of  failure 
to  properly  adjust  the  items  to  correspond  with  the  cor- 
rections made  in  proving  the  others,  and  such  errors  are 
disclosed  by  re-adding  each  page  of  the  trial  balance  and 
proving  the  footings  as  outlined  above. 

Besides  being  exceptionally  easy  to  prove,  a  consider- 
able advantage  accrues  to  this  form  of  trial  balance  in 
connection  with  systems  of  internal  check,  particularly 
in  connection  with  branch  offices,  as  the  entries  affecting 
each  account  or  each  class  of  accounts  each  month  are 
given  in  the  trial  balance  and  the  bookkeeper  at  the 
branch  can  usually  prepare  a  report  covering  the  source 
of  the  items  affecting  the  principal  General  Ledger  Ac- 
counts ;  this  report  to  be  used  by  the  auditor  at  the 
home  office  in  analyzing  the  various  transactions  and 
verifying  the  entries  to  all  of  the  accounts. 


TRIAL    BALANCE  237 


C.  P.  A.  Questions 

1.  Does  a  trial  balance  in  which  the  aggregate  of 
debits  and  credits  correspond  prove  the  books  to  be  cor- 
rect?   If  not,  explain  why  it  does  not.     (Penn.) 

2.  Explain    how   one    should   proceed    to   detect   an 
error  in  a  trial  balance.     (N.  Y.) 

3.  Trial  Balance: 

(a)  Describe  the  same  and  its  uses. 

(b)  Do  you  consider  its  use  necessary?  (N.  J.) 

4.  Outline  the  different  plans  of  preparing  a  trial 
balance  and  give  the  relative  advantages.     (XXX) 


CHAPTER  XXII. 
Profit  and  Loss  Account. 

In  closing  the  books  at  the  end  of  a  period  it  will 
be  found  that,  provided  the  accounts  have  been  adjusted 
to  show  their  true  position,  every  account  therein  rep- 
resents either  the  progress  of  the  undertaking  up  to 
that  particular  point  or  the  condition  of  the  various 
elements  of  value  as  at  that  particular  moment. 

Those  relating  to  the  condition  of  affairs  are  allowed 
to  remain  on  the  books,  while  those  representing  progress, 
or  which  are  required  in  determining  the  progress,  are 
transferred  to  an  account  which  summarizes  the  results 
obtained. 

Profit  and  Loss  Account. 

Such  an  account  is  usually  termed  the  Income,  Rev- 
enue, Loss  and  Gain,  or  Profit  and  Loss  Account. 

There  is  a  considerable  lack  of  preciseness  in  ac- 
counting terminology  in  connection  with  the  use  of  the 
term  Profit  and  Loss  as  applied  to  the  statement  dis- 
playing the  profits  or  losses  of  a  concern.  Often  it  is 
intended  to  signify  an  account  containing  sub-divisions 
for:  Manufacturing,  Trading,  Administration,  Net 
Profits  and  Profit  and  Loss  Appropriation  items,  while,  in 
other  cases,  the  Manufacturing  and  Trading  sections  are 
presumed  to  be  separate  accounts  and  the  remaining  three 
sections  are  considered  as  the  Profit  and  Loss  Account. 

Separate  accounts  in  the  ledger  would  assuredly  be 
used  to  contain  the  various  classes  of  items  and  it  is 
undoubtedly  proper  to  apply  the  term  Profit  and  Loss 
to.  the  one  displaying  the  ordinary  business  profit  of  the 
concern  and  the  causes  leading  thereto.  Likewise  the 


PROFIT  AND  LOSS  ACCOUNT  239 

statement  prepared  from  the  three  accounts  may  be 
designated  by  the  same  term,  as  it  contains  the  same 
information.  The  only  difference  being  that  it  dwells 
more  fully  upon  the  source  of  the  profits. 

Manufacturing  Section. 

The  Manufacturing  Section  is  intended  to  disclose 
the  results  of  manufacturing  during  the  period  under 
review.  The  principal  items  going  to  make  up  this 
section  are: 

The  Cost  of  Material  Consumed, 

The  Cost  of  Labor,  and 

The  Expense  of  the  Factory. 

The  account,  therefore,  should  be  divided  to  show  first, 
the  prime  cost  (cost  of  labor  and  material),  then  the  com- 
pleted cost  of  the  goods  manufactured  and  would  appear 
similar  to  the  following: 

Manufacturing 

To  Cost  of  Material  Used:  By  Prime  Cost, 

Inventory,  raw  ma-  Carried  forward  X 

terial      beginning 

of  period  X 

Purchases  X 

X 

Less    Inv.    end    of 
period  X     X 

To  Labor  X 


XXX  XXX 


To  Prime  Cost,  bro't  By      Inventory      partly 

down  X  m'f'd    goods,     last    of 

Inventory,  partly  period  X 

m'f'd    goods,    be- 
ginning   of  period  X  By  Cost  of  goods  m'f'd 
Power,  Reserve  for  carried  for'd  X 
Dep.    on  machin- 
ery, etc.                           X 

XXX  XXX 


240  ACCOUNTING  PRINCIPLES 

The  inventory  of  partly  manufactured  goods  at  the 
end  of  the  period  should  not  be  deducted  from  the  in- 
ventory at  the  beginning  of  the  period  for  it  contains 
portions  of  the  items  consumed  during  the  period  as  well 
as  of  the  original  inventory. 

Trading  Section. 

This  section  covers  the  sale  of  the  goods  and  the 
profit  thereon.  In  a  purely  trading  concern  such  items 
as  Infreight,  Duty,  etc.,  would  have  to  be  included  in 
this  section,  but  in  a  manufacturing  concern  they  would 
be  a  portion  of  the  cost  of  manufacture  and  would  appear 
in  the  Manufacturing  Section. 

The  Trading  Section  should  be  arranged  to  disclose 

The  Cost  of  the  Goods  Sold  (the  Turnover), 

The  Net  Sales, 

The  Gross  Profit, 

The  Expense  of  Selling,  and 

The  Profit  on  Trading. 

In  form,  it  would  be  as  follows : 
Trading 

To  Cost  of  Goods  sold:  By  Sales:  X 

Inventory,  Finished  Less  Returns,   Allow- 
Goods,   beginning  ances  or  Trade  Dis- 

of  period  X  counts  X     X 

Cost  of  Goods  m'f'd 
brought  down          X 

XX 

Less  Inventory,  end 

of  period  X     X 


To  Gross  Profit,  car- 
ried for'd 


XXX  XXX 


PROFIT  AND  LOSS  ACCOUNT  241 

To  Selling  Expense:  By  Gross  Profit: 

Salesmen's  Salaries  X  bro't  down  X 

Commission  X 

Traveling    Expense  X 

Rent  of  Salesroom  X 
Cartage  or  Freight 

outwards  X     X 

Reserve  for  Bad 
Debts  (based  on 
Sales)  X 

To  Profit  on  Trading, 
carried  for'd  X 

XXX  XXX 

Administration  Section. 

The  Administration  Section  is  intended  to  contain  all 
items  which  relate  to  the  expense  of  conducting  the  busi- 
ness. 

The  information  usually  desired  is: 

The  Expense  of  Conducting  the  Business,  and 
The  Ordinary  Business  Profit. 
In  form  it  would  be  as  follows : 

Administration 

To  Management  or  Office  By  Trading  Profit,  bro't 

Salaries  X  down                                X 

General  Expense  X  Income  not  directly  con- 

OfHce  Supplies  X  nected  with  Sales: 

Rent  X  Rent  of  Store,  etc.             X 

To     Ordinary     Business 

Profit,  carried  for'd  X 


XXX  XXX 

Net  Profit  Section. 

This  portion  of  the  statement  receives  all  those  items 
which  are  a  direct  result  of  the  excess  or  deficiency  of 
Capital  or  which  are  not  in  the  ordinary  run  of  business. 
As  credits,  such  items  as  Income  from  outside  invest- 
ments or  Cash  Discount,  secured  owing  to  the  ability  of 
the  firm  to  make  prompt  payment,  are  shown ;  while 


242  ACCOUNTING  PRINCIPLES 

such  items  as  Interest  paid  on  Loans  or  Bonds,  etc.,  or 
Unusual  Losses  represent  the  charges  thereto. 

The  Ordinary  Business  Profit  of  the  concern  is  the 
basis  on  which  Goodwill  is  valued,  therefore,  any  income, 
expenses  or  losses  that  occur  which  are  not  in  the  or- 
dinary course  of  business  or  which  may  be  traced  to 
capital  that  is  not  required  in  the  business  or  which  the 
business  requires,  but  which  must  be  received  from  out- 
side sources,  should  be  included  here. 

Such  a  statement  would  appear  as  follows : 
Net  Profit 

To   Expenses,    incidental  By     Ordinary     Business 

to  securing  capital:  Profit,  bro't  down          X 

Interest  on  Loans,  etc.  X  Income    from    Invest- 

Cash  Discount  on  Sales  X  ments  X 

To  Unusual  Losses:  Cash  Discount  on  Pur- 
Defalcations,  Fire,  etc.  X  chases  X 


XXX  XXX 


Considerable  divergence  of  opinion  exists  in  connec- 
tion with  the  treatment  of  Cash  Discounts,  and  the  items 
will  be  found  in  either  section  of  the  Profit  and  Loss 
Account. 

We  have  placed  them  in  the  Net  Profit  Section  for, 
in  our  belief,  they  represent  the  result  of  a  lack  of  or 
a  sufficiency  of  capital. 

Cash  Discount  of  Purchases  is  not  an  element  of  cost 
for  surely,  if  a  profit  is  made  during  any  one  period  of 
a  company's  existence,  owing  to  Cash  Discounts  on  Pui 
chases,  it  must  be  due  to  financies  rather  than  to  the 
ability  to  purchase  cheaper. 

In  selling  the  concern,  although  possibly  the  fact  that 
the  firm  has  always  discounted  its  bills  may  be  of 
some  value,  consideration  would  not  be  given  it  in  esti- 
mating the  goodwill  value.  The  ordinary  business 


PROFIT  AND  LOSS  ACCOUNT  243 

profit  of  the  concern  as  displayed  by  the  Profit  and  Loss 
Account  should  not,  for  this  reason,  be  disturbed  by 
the  inclusion  of  Discount  on  Purchases  in  the  Manu- 
facturing or  Trading  Accounts.  The  discount  should 
appear  in  the  Net  Profit  Section  below  the  item  Ordin- 
ary Business  Profit. 

The  same  argument  holds  true  of  Cash  Discount  on 
Sales.  It  has  been  asserted  that  such  a  discount  is  purely 
a  reduction  of  the  selling  price  of  goods.  Possibly  it  is 
in  some  cases,  but  in  general,  it  is  an  after  consideration 
and  is  in  the  nature  of  an  offer  made  by  the  seller  in  an 
effort  to  secure  the  payment  of  accounts  in  advance  of 
their  due  date ;  the  acceptance  thereof,  depending  entirely 
upon  the  finances  of  the  purchaser. 

Cash  Discounts  on  Purchases  are  undoubtedly  a 
question  of  finances  rather  than  of  cost  and  as  Cash  Dis- 
count on  Sales  is  the  effect  of  the  same  transaction,  but 
in  the  other  persons  books  it  must  also  be  a  question 
of  finances.  It  would,  therefore,  appear  in  the  Net  Profit 
Section  of  the  Profit  and  Loss  Account. 

Profit  and  Loss  Appropriation  Section. 

This  section  is  virtually  a  transcript  of  the  Undivided 
Profits  Account.  It  is  intended  to  show  the  profits  avail- 
able for  distribution  and  their  disposition.  It  might 
contain  the  following  items : 

P.  &  L.  Appropriation 

(Partnership) 

To  Interest  on  Capital  X  By  Balance  from  Previous 

To  Apportionment  Year  X 

amongst  Partners  X  XXX  By   Net   Profit,    Current 

Year  X 

(Corporation)  By   Profit  from    Sale   of 

To  Special  Reserves  X  Fixed  Assets  X 

To  Dividends  X  (If    apportionable     over 

To     Balance     (Undi-  prior  years) 


vided  Profits)  X  XXX  XXX 


244  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  Describe  the   process   of   closing  the  books   of  a 
corporation  at  the  end  of  a  fiscal  year,  showing  a  Trading 
and  a  Profit  and  Loss  Account  and  explaining  the  treat- 
ment  of   reserves   for   depreciation   and   for   bad   debts, 
as  well  as  for  the  surplus  or  deficiency  resulting  from 
the  operations  of  prior  years.      (N.  Y.) 

2.  Explain    the   difference   between    a   Trading   and 
a  Profit  and  Loss  Account.     (N.  Y.) 

3.  (a)   What  constitutes  Manufacturing  Cost?     (b) 
What  constitutes  Selling  Cost?      (c)   What  relation  do 
cumulative  preferred  stock  dividends  bear  to  cost  of  op- 
erating?    (Mich.) 

4.  Wlien  preparing  a  Trading  and  Profit  and  Loss 
Account  at  the  end  of  a  fiscal  year,  in  what  manner  would 
you  treat  the  following  subjects: 

(1)  Surplus   or   deficit   brought   forward   from 

prior  year? 

(2)  Reserves   for   Depreciation? 

(3)  Reserves  for  Bad  Debts? 

(4)  Interest  on  Bonds? 

(5)  Dividends  on  stock? 

(6)  Surplus  or  deficit  carried  forward  to  suc- 

ceeding year?     (N.  Y.) 

5.  State   your   understanding   of   the    difference   be- 
tween Gross  Profit  and  Net  Profit.     (111.) 

6.  In  preparing  a  statement  of  the  earnings  of  a 
business,  covering  a  period  of  five  years,  how,  in  order 
to  determine  what  the  average  earning  capacity  of  said 
business  had  been,  should  the  expenditure  for  interest 


PROFIT  AND  LOSS  ACCOUNT  245 

paid  on  bills  payable  and  loans,  and  on  accounts  pay- 
able be  considered?     (N.  Y.) 

7.  After    auditing    the    books    of    a    manufacturing 
company  for  a  period  of  ten  years,  you  are  asked  to  give 
a  certificate  as  to  the  net  earnings  of  the  business  for 
those  ten  }rears  for  the  purpose  of  a  sale  based  on  the 
earning  capacity  of  the  property.     What  items  of  ex- 
pense,  heretofore   charged  annually   through  the   Profit 
and  Loss  Account,  may  be  properly  eliminated   in   the 
preparation  of  your  certificate,  and  why?     (Wash.) 

8.  Without  using  figures,  draft  a   Profit  and  Loss 
Account  in  which  Gross  Profits  are  distinguished  from 
Net  Profits.     (Wash.) 

9.  Define   and   differentiate  the   following   kinds   of 
accounts:     (a)   real  and  nominal,   (b)   personal  and  im- 
personal, (c)  current  and  summary,  (d)  controlling  and 
specific.     (N.  Y.) 

10.  In  making  up  a  statement  of  Profit  and  Loss, 
where  would  you  show   (a)   cash  discount  allowed  cus- 
tomers for  prompt  payment  of  bills,   (b)   cash  discount 
deducted  in  payment  of  invoices  of  your  clients?     Ex- 
plain briefly  and  give  reasons.     (N.  Y.) 

11.  Give  proper  disposition  of  any  balance  appear- 
ing in  a  Profit  and  Loss  Account  at  the  end  of  a  fiscal 
year.      (111.) 

12.  In  summarizing  the  nominal  accounts  of  a  man- 
ufacturing concern  to  determine  the  result  of  operations 
for  a  period:     (a)   What  would  be  the  order  and  char- 
acter of  the  three  closing  accounts?     (b)   What  nature 
of  accounts  form  the  elements  of  each?     (111.) 

13.  What  is  the  purpose  of  a  trading  account,  and 
what   general    result   should   it   show?     In   closing   the 


246  ACCOUNTING  PRINCIPLES 

ledger  what  disposition  would  be  made  of  the  balance  of 
the  trading  account?     (N.  Y.) 

14.  State  the  different  steps  in  the  process  of  closing 
the  ledger  at  the  end  of  a  fiscal  period  and  give  the  rea- 
son for  each  step.     (N.  Y.) 

15.  Explain   the   difference   between   a   Trading   Ac- 
count and  a  Profit  and  Loss  Account  and  state  in  which 
account  you  would  place  the  following  items,  giving  your 
reasons : 

Purchases.  Sales. 

Carriage  and  Freight.  Stock  on  Hand. 

Debenture  Interest.  Returns. 

Depreciation.  Discounts. 

Allowances.  Fuel. 

Bad  Debts.  Packages. 

Wages.  Directors'  Fees. 

Commission.  (Inst.  of  C.  A.) 
Advertising. 


CHAPTER  XXIII. 

Balance  Sheet 

A  Balance  Sheet  is  an  account  prepared  from  double 
entry  books  to  display  the  status  of  a  business  as  at  a 
particular  moment.  It  is  in  the  nature  of  a  Trial  Bal- 
ance taken  immediately  after  closing  the  books,  but  dif- 
fers to  the  extent  that  every  account  therein  represents 
the  summing  up  of  some  element  of  value;  whereas,  the 
Trial  Balance,  taken  at  any  other  time,  would  contain 
many  balances  relating  to  the  previous  period  and  also 
many  accounts  representing  the  progress  of  the  business. 

The  object  of  a  Balance  Sheet  is  to  display  a  true 
statement  of  the  financial  condition  of  a  concern.  It  is 
well,  however,  to  bear  in  mind  that  such  a  statement 
taken  as  a  whole  is  not  to  be  construed  as  a  statement 
of  facts  but  rather  as  a  statement  of  opinion,  the  value 
of  which  varies  greatly  with  the  knowledge  and  experi- 
ence of  the  persons  making  it  up.  True,  all  of  the  items 
therein  are  facts  if  the  statement  is  prepared  by  a  per- 
son versed  in  the  work,  but,  owing  to  the  methods  of 
valuing  the  different  classes  of  assets  and  the  various 
degrees  of  responsibility  existing  in  regard  to  the  lia- 
bilities, it  cannot  be  accepted  as  anything  more  than  a 
synopsis  of  Ledger  Balances  which  have  been  adjusted 
to  show  the  true  condition  of  each  element  of  value  ac- 
cording to  the  prevailing  rule  of  its  valuation. 

To  the  extent  that  these  balances  have  been  adjusted 
by  the  auditor  to  display  the  proper  value  of  the  accounts 
for  Balance  Sheet  purposes,  the  balance  sheet  may  be 
accepted  as  his  opinion  of  the  condition  of  the  concern. 


248  ACCOUNTING  PRINCIPLES 

If  a  statement  is  desired  for  any  purpose  other  than 
that  outlined  above,  say  to  display  the  value  of  the 
assets  in  case  of  liquidation  or  to  determine  the  sale 
value  of  the  business,  some  other  method  of  valuation 
and  of  displaying  the  results  must  be  used  and,  even 
then,  we  have  but  the  opinion  of  some  one  as  to  the 
probable  result  or  value. 

In  the  preparation  of  Balance  Sheets,  much  depends 
upon  the  knowledge  and  ability  of  the  auditor  to  dis- 
play the  facts  in  a  manner  that  they  may  be  easily  and 
properly  interpreted.  Items,  such  as  Reserve  Accounts, 
that  are  offsets  to  others,  should  be  deducted  from  their 
major  account,  while  items  of  a  class  like  Surplus  and 
Reserve  Funds  should  be  grouped  or,  possibly,  if  their 
individuality  is  not  important,  be  shown  as  one  item. 
Care  should,  however,  be  taken  that  the  items  grouped 
are  identical,  otherwise  the  term  applied  to  the  group 
may  greatly  mislead.  It  is  also  advisable  to  display  like 
groups  in  as  close  proximity  as  possible  so  that  they 
in  turn  may  be  taken  individually,  collectively  or  in  com- 
parison with  each  other  as  desired. 

One  of  the  principal  uses  to  which  a  balance  sheet 
is  put  is  in  connection  with  displaying  the  ability  of  a 
concern  to  liquidate  its  current  liabilities  readily,  in  con- 
nection with  loans  from  bankers,  etc.  Such  a  Balance 
Sheet  should  display  prominently  those  items  which  the 
banker  considers  most  important. 

His  loans  are  usually  for  but  a  short  period  and  for 
this  reason  he  is  not  concerned  to  any  great  extent  with 
the  fixed  assets.  We  should,  therefore,  display  the  Cur- 
rent items  first,  placing  on  one  side  the  Current  Assets 
and  on  the  other  the  Current  Liabilities.  By  having 
them  in  juxtaposition  with  each  other  he  may  easily 
compare  the  one  with  the  other  and  determine  the  excess 


BALANCE  SHEET  249 

of  the  one  over  the  other,  and  the  possibility  of  meeting 
the  various  claims  or  any  other  liabilities  that  may  be 
incurred  from  the  assets  available  and  we  should  display 
the  items  accordingly. 

Certain  of  the  assets  are,  undoubtedly,  not  as  readily 
realizable  as  others,  while  some  of  the  claims,  though 
current,  may  not  require  attention  as  soon  as  others, 
therefore,  we  should  endeavor  to  show  the  Assets  in  the 
order  of  their  availability  and  the  Liabilities  in  the  order 
of  their  claims  upon  the  estate. 

Fixed  Liabilities  are  usually  secured  by  the  Fixed 
Assets  and  it  is  well  to  place  these  items  opposite  each 
other  for  easy  comparison. 

In  creating  the  capital,  there  may  have  been  certain 
elements  included  which  are  of  uncertain  value,  and 
which,  at  best,  would  only  exist  in  an  intangible  form. 
These  are,  to  a  certain  extent,  offsets  to  the  Capital  and 
they  should  appear  just  opposite  it  so  that,  if  desired, 
they  may  be  mentally  deducted  therefrom  to  determine 
the  total  tangible  assets  in  the  business. 

Expenses  paid  during  one  period  that  properly  belong 
t<>  another,  although,  possibly,  not  current  assets,  tend 
to  reduce  the  requirements  of  current  liabilities ;  hence, 
may  properly  be  included  amongst  the  Current  Assets 
to  facilitate  the  determination  of  the  net  current  avails. 

The  general  order  of  the  groups  of  items  as  we  have 
outlined  them,  is  not  intended  to  apply  in  all  cases,  for 
the  relationship  of  the  party  for  whom  the  balance  sheet 
is  to  be  prepared  must  be  considered  when  determining 
the  proper  form.  A  bond  holder,  whose  claim  does  not 
mature  for  ten  or  twenty  years,  would  not  be  particu- 
larly interested  in  the  current  items  and,  for  him,  we 
should  display  the  secured  claim  in  comparison  with 


250 


ACCOUNTING  PRINCIPLES 


the  securities  held  and  should  give  these  items  first 
position. 

The  stockholders  would  be  most  interested  in  the 
disposition  of  the  capital  invested  and  would  wish  to 
learn  the  amount  permanently  invested  and  the  propor- 
tion retained  for  working  capital.  In  order  that  they  may 
secure  this  information  readily,  the  Capital  and  Fixed 
Liabilities  would  be  shown  first,  in  comparison  with  the 
Capital  Assets,  followed  by  the  current  items. 

The  following  illustrates  a  common  and  very  de- 
sirable form  of  Balance  Sheet: 


BALANCE  SHEET  OF  THE  "X"  CO.,  AS  AT.. 
CURRENT  ASSETS 


191. 


Cash 

X 

Investments,  Bonds,  etc. 

X 

Bills  Receivable 

X 

Accounts  Receivable 

X 

X 

Less  Reserve  for 

Bad  Debts 

X 

X 

Inventories: 

M'f'd  Goods 

X 

Goods  in  Process 

of  Manufacture 

X 

Raw  Material 

X 

X 

Investments,  Real  Estate, 

etc. 

X 

Deferred  Charges: 

Unexpired  Insurance        X 
Rent  paid  in  advance       X 


X     XX 


FIXED  ASSETS 
Real  Estate 
Buildings 
Machinery 
Furniture  and  Fixtures 

X 
X 
X 

X 

Less  Res.  for  Dep. 

X 
X 

X 
X 

XX 
XX 

Goodwill 

CURRENT  LIABILITIES 
Bills  Payable  X 

Accounts  Payable  X 

Sundry  Charges  Accrued: 

Int.  on  Bills  Payable        X 
Taxes  X 

Int.  on  Bonds  X     X 


FIXED  LIABILITIES 
First  Mortgage  Bonds  X 


PROPRIETORSHIP 

Capital  X 

Undivided  Profits  X 


XX 


xxxx 


XX 


XX 

xxxx 


Contingent  Liabilities: 
Claim  re 


BALANCE  SHEET  251 


C.  P.  A.  Questions 

1.  What  is  a  (a)  Balance  Sheet,  (b)  Trial  Balance? 
(R.   I.) 

2.  Why    must   the    Revenue    Account   be    completed 
before  a  Balance  Sheet  can  be  prepared?     (R.  I.) 

3.  What  are  the  principal  differences  between  a  trial 
balance  taken  before  the  books  are  closed  and  one  taken 
directly  after  they  are  closed?     (N.  Y.) 

4.  In   presenting  a   balance   sheet,   what   items   are 
matters  of  fact  and  what  items  are  opinions,  and,  taken 
as  a  whole,  are  you,  as  auditor,  establishing  a  fact  ov 
an  opinion?      (111.) 

5.  In  drawing  up  a  balance  sheet  is  it  desirable  to 
show  the  assets  and  liabilities  by  groups,  and  if  so,  into 
what  groups  would  you  classify?    Give  reasons  for  your 
classification.     (N.  Y.) 

6.  In  the  preparation  of  a  balance  sheet  for  a  man 
iif;  ir  hiring  company,  what  general  plan  would  you  fol- 
low in  determining  the  order  of  sequence  in  which  the 
assets  and  liabilities  should  be  stated?     (N.  Y.) 

7.  Without  using  figures,   outline  a   Balance   Sheet 
for    a    manufacturing    corporation    and  .state    how    you 
would  treat  each  of  the  following  items: 

(a)  Depreciation  on  plant. 

(b)  Interest  payable  accrued. 

(c)  IJnexpired  insurance. 

(d)  Provision  for  Bad  and  Doubtful  Accounts 

Receivable.      (Wash.) 

8.  On    January   1,   1908,   the   condition    of   a   small 
trading  company  as  determined  by  an  examination  of 
that  date  was  as  follows: 


252  ACCOUNTING  PRINCIPLES 


Assets 

Furniture  and  fixtures  $2,000 
Cash  500 

Notes  Receivable  3,000 

Accounts  Receivable  5,000 

Merchandise  on  hand  4,000     $14,500 

Capital  Stock  and  Liabilities 

Capital  Stock  $5,000 

Notes  Payable  3,000 

Accounts  Payable  6,000 
Surplus  500     $14,500 


During  the  month  of  January  the  bookkeeper  made 
all  entries  in  the  Cash  Book  and  in  the  Sales  Book,  but 
made  no  Journal  entries  and  did  not  post  his  Ledger. 
In  addition  to  the  entries  appearing  in  the  Cash  Book 
and  on  the  Sales  Book  the  following  transactions  took 
place  during  January :  Merchandise  purchased  on  credit 
amounting  to  $6,000,  notes  payable  amounting  to  $6,000 
renewed,  special  allowance  of  $500  made  to  customers. 

The  Credit  Sales  Journal  had  two  columns,  one  for 
the  billed  amounts  and  the  other  for  the  cost  of  the 
goods  sold.  The  billed  amount  was  $8,000  and  the  cost 
was  $5,000. 

The  following  statement  gives  a  summary  of  the  cash 
receipts  and  disbursements  for  January: 

Cash  Received: 

Collected  from  customers  $4,000 

Collected  on  note  receivable  2,000 

Collected  on  merchandise  sold  and  not  entered 
on  sales  book  (cost  price  $500)  600       $6,600 

Cash  Payments: 

Interest  on  notes  payable  $      45 

Salaries  500 

Rent 

Sundry  expenses  300 

Accounts  payable  5,000       $6,045 


BALANCE  SHEET  253 

Prepare  balance  sheet,  January  31,  1908,  and  state- 
ment of  profit  and  loss  based  on  the  book  value  of  the 
merchandise.  (N.  Y.) 

1).  You  are  the  auditor  of  a  manufacturing  corpora- 
tion which  has  been  operating  five  years  and  which  has, 
amongst  other  accounts,  the  following,  viz.:  Plant  Ac- 
count, $700,000 ;  Reserve  for  Depreciation,  $200,000 ;  Sur- 
plus, $100,000.  The  officers  ask  you  to  certify  a  state- 
ment embracing  the  above  items  in  the  following  form, 
viz. :  Plant,  $700,000 ;  Surplus  and  Reserve  Accounts, 
$300,000.  State  (a)  whether  you  approve  same  and  (b) 
the  reasons  supporting  your  answer.  (Mass.) 

10.  A  corporation   has  an   issue  of  preferred  stock 
entitled  to  cumulative  dividends  of  1%  a  year.    The  com- 
pany has  paid  on  this  stock,  dividends  at  the  rate  of-  5% 
a  year  for  ten  years.     Should  the  arrears  of  dividends 
appear  on  the  balance  sheet,  and  if  so,  how?     (N.  Y.) 

11.  In  closing  a  set  of  books  state  how  you  would 
treat  the  following  on  ledger  and  financial  statement : 

Depreciation  on  machinery  $1,500 
Expenses  prepaid 

Discount  on  customers'  accounts  3%  1,080 

Salaries  and  wages  accrued                 .  675 

(N.  Y.) 


254 


ACCOUNTING  PRINCIPLES 


12.     Criticize  the  following  Balance  Sheet : 


Assets : 

Machinery,  at  cost 
Buildings,  at  cost 
Good  will 

Formation  expenses 
Inventory: 

Raw  material,  at  cost 


Merchandise  in  process  of  manufacture, 

at  cost 
Merchandise,  finished,  at  selling  price 


$10,000.00 


10,000.00 
23,000.00 


Bills  receivable,  face  value 
Accounts  receivable,  face  value 
Cash 

Liabilities : 

Capital  stock 
Bills  payable 
Accounts  payable 
Undivided  profits 

(Wash.) 


$70,000.00 

20,000.00 

25,000.00 

3,000.00 


43,000.00 

3,500.00 

22,000.00 

2,500.00 


$189,000.00 

$100,000.00 
50,000.00 
30,000.00 
9,000.00  $189,000.00 


CHAPTER  XXIV. 

Classified  Journals — Continued 

Now  that  we  have  covered  Controlling  accounts  and 
the  student  may  be  presumed  to  have  a  knowledge  of 
the  division  of  ledgers,  we  may  proceed  with  the  explana- 
tion of  the  more  complex  tabular  books. 

The  principal  advantages  to  be  derived  by  using  tabu- 
lar books  are  that  additions  may  be  proven  from  page 
to  page;  numerous  postings  of  a  class  may  be  treated  as 
one  item  and  posted  as  a  total ;  and  similar  items  may  be 
posted  in  detail  to  certain  records,  and  in  totals,  only,  to 
other  records,  as  in  the  case  of  a  sales  book,  the  individual 
items  of  which  are  posted  to  the  debit  of  the  customers 
accounts  in  the  customers'  ledger,  and  total  posted  to 
the  credit  of  sales  account  and  to  the  debit  of  the  con- 
trolling account  for  that  ledger  in  the  general  ledger. 
It  would  also  be  posted  to  the  credit  of  the  adjustment 
account  in  the  customers'  ledger  to  keep  that  ledger  in 
balance,  or  if  preferred,  where  a  system  of  proof  posting 
is  used,  the  total  of  each  individual  proof  sheet  could  be 
entered  in  the  adjustment  account,  keep/ng  the  ledger 
in  balance  from  day  to  day.  The  proof  sheets  repre- 
senting the  posting  from  each  book  of  original  entry, 
should  be  kept  separate  so  that  their  total  could  be  agreed 
with  the  total  as  displayed  by  the  book  of  original  entry. 

Cash  Journals. 

A  Cash  Journal  differs  from  an  ordinary  Classified 
Journal  only  to  the  extent  that  the  one  contains  columns 
for  the  cash  account  and  the  other  does  not.  The  fact 
that  the  cash  book  usually  requires  about  the  same  dis- 


256  ACCOUNTING  PRINCIPLES 

tribution  columns  as  the  journal  leads  to  the  combining 
of  the  two.  This  reduces  the  number  of  books  and,  to  the 
inexperienced,  greatly  simplifies  the  work  of  keeping 
a  record. 

In  general,  it  is  prepared  with  debit  and  credit  col- 
umns for  each  important  account  found  in  the  general 
ledger,  including  cash  and  the  accounts  representing 
the  subsidiary  ledgers.  Its  operation  is  so  very  simple 
and  so  easily  explained  that,  invariably  where  an  inex- 
perienced person  is  to  keep  the  books  and  where  the  ac- 
countant is  to  verify  the  work,  it  is  installed. 

Some  accountants  prefer  to  use  a  book  with  explana- 
tion columns  in  the  center  and  with  all  of  the  debit 
accounts  on  one  side  and  all  of  the  credit  accounts  on 
the  other,  as  this  greatly  facilitates  the  proof  of  the  work 
— the  total  of  the  columns  on  one  side  equaling  the  total 
of  the  columns  on  the  other.  Others  prefer  that  the  debit 
and  credit  columns  for  each  account  appear  together. 
This  seems  to  be  the  easier  to  operate  in  connection  with 
the  majority  of  accounts,  but,  as  a  considerable  number 
of  accounts  do  not  receive  entries  except  at  rare  inter- 
vals, other  than  to  one  side,  as  in  the  case  of  expense, 
accounts,  the  majority  of  entries  to  which  are  debits,  it 
causes  a  considerable  waste  of  space  or  else  the  elimina- 
tion of  the  columns  that  are  not  required. 

Wherever  both  sides  of  all  accounts  are  represented 
it  is  easy  to  prove  the  entries  on  a  page,  as  the  debits 
and  credits  alternate  across  the  page;  but  where  some 
of  the  columns  are  omitted,  confusion  results  in  extend- 
ing the  amounts  into  the  respective  columns  as  well  as 
in  balancing. 

In  preparing  a  cash  journal,  columns  should  be 
provided  for  each  subsidiary  ledger,  debit  and  credit; 
Discount  and  the  Cash  Accounts,  debit  and  credit ;  Bank 


CLASSIFIED  JOURNALS— Continued  257 

Account  for  each  bank,  debit  and  credit,  where  they 
are  desired,  as  well  as  for  Sales,  Purchases  and  Expense 
Items.  It  is  also  essential  that  columns,  debit  and  credit, 
be  provided  to  contain  the  miscellaneous  items  which  have 
not  been  supplied  with  special  columns. 

Wherever  the  Miscellaneous  Columns  have  been  pro- 
vided, it  is  not  necessary  to  have  a  set  of  columns  headed 
"General  Ledger,"  for  the  one  would  contain  the  same 
class  of  items  that  appear  in  the  other. 

Offlimes  entries  occur  in  adjusting  accounts  which 
are  unusual  and  for  which  columns  have  not  been  pro- 
vided, as  in  connection  with  credits  to  expense  accounts 
or  debits  to  sales,  and,  instead  of  making  an  entry  in 
the  Miscellaneous  column,  a  red  ink  entry  is  made  in  the 
regular  column.  This  makes  the  proving  of  the  book  still 
more  complex,  unless  the  deductions  are  actually  made, 
and  if  they  are  made  it  becomes  rather  hard  to  prove  the 
ledgers  or  localize  errors  by  verifying  the  charges  and 
credits  to  the  accounts  for  the  period  under  review.  For 
these  reasons  the  red  ink  deductions  should  be  avoided. 
As  an  alternative  the  item  could  be  placed  in  the  Miscel- 
laneous column  and  posted  separately. 

In  closing  the  Cash  Journal  or  any  Classified  Journal 
at  the  end  of  each  month,  it  is  customary  to  total  each 
column  on  a  different  line  and  extend  the  amount  into 
the  column  representing  the  General  Ledger.  The  total 
of  the  General  Ledger,  or  Miscellaneous  column,  will  then 
represent  the  total  charges  and  credits  to  the  General 
Ledger  from  the  Journal  for  that  period. 

Ledger  Journal. 

Some  concerns,  even  very  large  ones,  are  able  to  sum- 
marize their  transactions  so  that  no  ledger  is  necessary 
for  recording  their  business.  They  usually  operate  a 


258  ACCOUNTING  PRINCIPLES 

Cash  Journal  with  columns  provided  for  nearly  all  of 
the  accounts  and  with  Miscellaneous  columns,  debit  and 
credit,  for  the  unusual  entries.  They  also  have,  usually 
at  the  top  or  the  side  of  each  page,  distribution  accounts 
into  which  the  balances  brought  forward  from  previous 
pages,  may  be  carried,  as  well  as  the  items  appearing  on 
that  page  in  the  Miscellaneous  column. 

To  illustrate:  A  Cash  Journal  has  been  provided 
as  above,  with  columns  for  Cash,  Bank,  Expense,  Sales, 
Purchases,  Customers,  Discounts,  etc.,  and  also  Miscel- 
laneous items.  Adjacent  to  the  Miscellaneous  columns 
is  a  narrow  portion  provided  with  columns  similar  to 
a  ledger  and  in  this  section  are  found  accounts  with 
Sundries,  including  Capital,  Surplus,  Plant,  Inventories, 
etc.,  which  would  possibly  not  receive  many  additional 
entries  and  which  might  be  fully  explained  in  some  other 
portion  of  the  book,  Bills  Receivable,  Bills  Payable, 
Miscellaneous  Income  or  Expense  Accounts,  etc.  Into 
these  accounts  all  items  appearing  in  the  Miscellaneous 
columns  are  carried  so  that  at  all  times  the  adjacent 
ledger  accounts  will  balance  the  Miscellaneous  columns. 
Whenever  it  becomes  necessary  to  carry  the  footings 
forward  to  another  page,  the  balances  ol  the  ledger  ac- 
counts must  be  carried  also,  unless  short  leaves  have 
been  provided  for  the  various  Journal  Columns  and  the 
Ledger  portion  of  the  book  is  allowed  to  extend  beyond 
them. 

Voucher  Register. 

The  tendency  of  modern  times  is  to  eliminate  as 
much  of  the  detail  work  as  is  possible  in  connection  with 
accounts.  Much  was  accomplished  upon  the  advent  of 
controlling  accounts,  which  allow  the  books  of  large  con- 
cerns to  be  divided  amongst  a  number  of  operators  or 


CLASSIFIED  JOURNALS— Continued  259 

placed  in  the  cities  of  easiest  access  to  the  various  fields 
of  operation,  and  upon  the  adoption  of  tabular  books, 
which  reduced  the  volume  of  posting  and  improved  the 
accuracy  of  the  work,  but  undoubtedly  the  greatest  ad- 
vance of  all  is  the  voucher  system  of  keeping  accounts 
with  creditors. 

The  great  advantages  of  the  voucher  system  are  that 
practically  no  posting  is  required;  all  details  relative 
to  incurring  a  claim,  receiving  and  apportioning  the 
benefits  and  its  ultimate  payment  with  the  acknowledg- 
ment of  the  payee  and  the  authority  and  verification  of 
each  act  in  connection  with  the  claim  are  recorded  and 
retained  upon  a  few  slips  of  paper;  no  unauthorized 
claim  can  be  paid ;  the  effectiveness  of  an  audit  is  greatly 
increased  and  the  expense  thereof  greatly  reduced. 

Its  disadvantages  are  that  a  considerable  expense  is 
entailed  on  account  of  filing  and  recording  the  vouchers 
and  in  the  labor  involved  in  having  them  vised  by  the 
various  officials,  and  also  that  no  ledger  accounts  are 
available  for  reference  in  future  years. 

In  operation,  the  system  consists  of  preparing  a 
voucher  for  each  claim  the  moment  it  is  received  and 
of  having  every  step  in  the  progress  of  the  claim  and 
the  articles  it  represents  recorded  and  vised  by  the  per- 
sons responsible.  Each  claim  is  considered  as  a  separate 
account  and  is  treated  much  the  same  as  "Sundry  Debt- 
ors." 

The  forms  used  to  properly  record  the  transactions 
vary  with  every  business.  They  usually  consist  of  a 
check  and  a  voucher  or  possibly  a  combination  of  the  two. 

The  check  might  be  the  standard  form  with  the  ad- 
dition of  a  voucher  number  for  cross  reference,  or  it 
might  contain  a  summary  of  the  transaction,  either  on 
its  face  or  oh  the  back.  It  often  includes  a  form  of  re- 


260  ACCOUNTING  PRINCIPLES 

ceipt  for  the  signature  of  the  payee,  but  as  this  does  not, 
except  in  the  case  of  disputed  claims,  serve  to  bind  the 
payee  any  stronger,  the  plan  is  gradully  going  out  of  use. 

The  combined  check  and  voucher  is  likewise  disap- 
pearing, principally  on  account  of  the  objections  ad- 
vanced by  bankers  owing  to  the  labor  involved  in  hand- 
ling it  and  the  tendency  of  the  makers  to  increase  his  re- 
sponsibility by  demanding  that  he  see  that  it  is  properly 
receipted,  etc.,  before  paying,  and  also  because  the  record 
of  the  transaction,  discounts,  etc.,  becomes,  to  a  certain 
extent,  public  property. 

The  most  satisfactory  form  of  voucher  and  check  is  the 
one  that  leaves  with  the  payee  a  record  of  the  account  or 
items  that  the  check  is  intended  to  pay  and  "which  does 
not  encumber  the  bank  with  any  paper  other  than  the 
standard  check  and  which  also  retains  with  the  original 
voucher  an  exact  copy  of  the  check. 

We  attach  forms  herewith  that  supply  the  require- 
ments and  which  are  intended  for  use  with  a  typewriter, 
preferably  one  equipped  with  two  sets  of  type,  one  gothic 
and  the  other  pin-point  and  a  lawyer's  indelible  ribbon, 
the  writing  of  which  cannot  be  removed  either  with  an 
eraser  or  with  chemicals  after  it  has  had  an  opportunity 
to  work  into  the  paper. 


Seattle,  Wash.,  ...  191 Check  # 

Pay  to  the  order  of Vouch.  # 

Dollars  f 

To  The  First  National  Bank,  The  Western  Asphalt  Co., 
Seattle,  WTash. 

Pres. 

Treas. 

Detach  above  check  and  retain  this  remittance 
sheet  for  future  reference 

Statement  of  accounts  paid 191 Vouch.  # 

by  the  Western  Asphalt  Co.,  Seattle,  Wash. 


Seattle,  Wash., ......191 Check  # 

Vouch.   # 

.... Dollars   $ 


Expenditure  authorized  by         Extensions  O.  K. 
Goods  received  and  checked        Prices  and  Terms  O.  K. 


Statement  of  accounts  paid 191 Vouch.  # 

by  the  Western  Asphalt  Co.,  Seattle,  Wash. 


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02 


CLASSIFIED  JOURNALS— Continued  266 

Care  should  be  taken  to  see  that  the  printer  arranges 
both  sheets  so  they  will  align  properly  when  in  the 
machine. 

The  complete  account  of  the  transaction  having  been 
prepared,  it  becomes  necessary  to  arrange  some  plan  to 
properly  record  the  various  accounts  for  future  refer- 
ence and  to  incorporate  them  in  the  general  books. 

This  is  accomplished  by  the  aid  of  a  Voucher  Record 
or  Register  which,  to  be  on  the  double  entry  principal, 
must  provide  for  debit  and  credit  entries,  and,  to  provide 
for  the  easy  distribution  of  the  items  and  their  proof, 
should  be  of  the  tabular  plan. 

The  voucher  represents  an  Accounts  Payable,  hence, 
in  lieu  of  the  Accounts  Payable  Account,  we  will  have 
an  account  in  our  General  Ledger  headed  Vouchers  Pay- 
able. The  Voucher  Record  will  be  the  original  entry  for 
the  credits  to  this  account,  therefore,  we  must  provide 
a  column  for  these  credits.  The  credits  will  be  counter- 
balanced not  only  by  purchases  but  also  by  expense  or 
other  charges  of  every  kind;  therefore,  we  must  provide 
columns  for  receiving  these.  Many  of  the  items  will  be 
closely  related,  therefore,  we  should  group  the  columns 
under  appropriate  headings  to  facilitate  the  handling 
of  the  items  and  the  construction  of  accounts. 

In  connection  with  the  record  of  the  voucher  we 
should  allow  for  the  date,  number,  name  of  the  creditor, 
discount,  amount  of  the  claim  and  the  time  and  manner 
of  payment.  To  provide  for  the  charges  to  the  various 
accounts  we  need  only  provide  columns  for  their  dis- 
tribution and  also  a  special  set  of  columns  to  contain 
those  items  for  which  no  columns  have  been  provided. 

A  voucher  record  provided  as  outlined  above  may 
have  columns  for: 


266  ACCOUNTING  PRINCIPLES 

Issue : 

Date 

Voucher  No. 

Creditor 

Discount  on  Purchases 

Amount 
Payment : 

Date  or 

Check  # 
Distribution : 
Purchases 

Raw  Material 

Finished  Goods, 

In  Freight 

Duty 
General  Expense 

Salaries 

Rent 

Postage 

Stationery 
Selling  Expense 

Advertising 

Salaries 

Traveling 

Commission 

Out  Freight 

Rent 
Miscellaneous 

Account 

Folio 

Amount 

Such  a  voucher  record  only  provides  for  the  prompt 
payment  of  claims  and  a  voucher  will  be  required  imme- 
diatelv  that  a  claim  is  received. 


CLASSIFIED  JOURNALS— Continued  267 

In  many  concerns  certain  liabilities  are  incurred 
which  are  to  be  of  long  standing  and  which  it  may  or 
may  not  be  desirable  to  record  on  a  voucher.  To 
accommodate  such  transactions  and  also  to  provide  for 
Journal  Voucher  adjustments  we  should  provide  ad- 
ditional columns  adjacent  to  the  columns  intended  to 
contain  the  credits  to  Vouchers  Payable.  The  columns 
should  be  near  the  Vouchers  Payable  column  so  that  all 
credit  columns  will  be  together,  thereby  facilitating  the 
proving  of  the  pages.  These  extra  columns  will  contain 
credits  to  miscellaneous  accounts  in  the  general  ledger 
and  should  be  headed  as  follows : 

General  Ledger  Account,  Credit;  Folio;  Amount. 

Voucher  Distribution  Ledger  or  Journal. 

The  greatest  objections  to  the  Voucher  System  are  that 
usually,  an  enormous  book  is  used  to  record  and  distribute 
the  amounts  of  the  vouchers;  that  such  a  book  must  be 
specially  made  at  considerable  expense;  that  it  is  un- 
wieldy and  cumbersome  to  handle;  and,  that  the  greater 
portion  of  each  page  is  not  written  upon. 

These  objections  may  be  abated  by  the  adoption  of  a 
Voucher  Distribution  Ledger.  Such  a  Ledger  contains 
a  sheet  for  each  of  the  principal  classifications  of  charges 
and  each  sheet  is  provided  with  columns  for  each  sub- 
division of  the  principal  account  that  is  desired.  The 
Voucher  Record  then  only  requires  one  column  for  each 
group  of  accounts  instead  of  one  for  each  subdivision,  the 
Distribution  Ledger  containing  an  analysis  of  the  indi- 
vidual items  in  detail. 

To  illustrate: 

In  a  General  Expense  column  in  the  Voucher  Record 
we  may  include  all  items  relating  to  General  Expense, 
irrespective  of  department  or  kind. 


268  ACCOUNTING  PRINCIPLES 

On  the  Distribution  Ledger  Sheet  the- same  items  will 
again  appear,  but  carefully  classified,  possibly  under  head- 
ings: 

(a)  Office  Salaries 

(b)  Rent 

(c)  Charity 

(d)  Telephones  &  Telegrams 

(e)  Stationery 

(f)  Postage 

(g)  Light  &  Heat 

(h)   Janitor  &  Supplies 
(j)   Miscellaneous 

The  total  of  the  items  on  the  distribution  sheet  must 
equal  the  total  of  the  column  containing  the  same  items 
in  the  Voucher  Record  and,  instead  of  posting  the  total 
of  the  items  as  appearing  in  the  Voucher  Record  to  the 
General  Ledger,  the  total  of  the  respective  columns  are 
posted  from  the  Distribution  Ledger. 

In  order  to  reduce  the  expense  of  preparing  the  sheets 
for  the  Voucher  Distribution  Ledger,  a  plan  of  lettering 
the  columns  may  be  used  to  represent  the  various  sub- 
divisions of  each  account,  then  the  same  style  of  ledger 
sheet  will  apply  for  each  classification ;  the  various  letters 
designating  the  exact  sub-division  of  the  account  to  be 
charged  as  determined  by  reference  to  the  distribution 
analysis  of  the  voucher,  on  the  back  of  the  voucher. 

To  illustrate: 

If  the  Distribution  Ledger  Sheet  is  to  be  used  to 
record  expense  items,  column  "a"  will  contain  Office 
Salaries,  but,  if  the  sheet  is  to  be  used  to  contain  Hauling 
Expenditures,  columns  "a"  will  answer  for  Teamsters' 
Salaries,  etc. 

An  alternative  method  is  to  provide  a  separate  sheet 
in  the  Distribution  Ledger  for  each  sub-account  and  to 


CLASSIFIED  JOURNALS— Continued  269 

have  columns  ruled  to  contain  the  entries  for  each  month 
separately.  At  the  end  of  each  month  the  totals  of  the 
entries  made  on  each  sheet  during  the  month  are  carried 
forward  to  a  special  Summary  Sheet  which  contains  a 
recap  of  the  items  of  a  class,  classified  according  to 
months.  When  totaled,  the  monthly  column  of  the  Sum- 
mary Sheet  should  equal  the  amount  of  the  controlling 
column  in  the  Voucher  Record. 

The  advantage  of  this  method  is  that  the  results  of 
each  mouth  may  be  easily  compared  with  other  similar 
periods  and,  if  Summary  Sheets  of  different  lengths  are 
used,  the  results  of  several  years  may  be  displayed  at 
once  without  rewriting. 


270  ACCOUNTING  PRINCIPLES 


C.  P.  A.  Questions 

1.  What    are    the   advantages    of    a    columnar    cash 
book?     (B.  I.) 

2.  Give  heading  for  a  combined  Cash  Book  and  Jour- 
nal and  state  what  you  consider  to  be  the  advantages, 
if  any,  and  disadvantages,  if  any,  of  such  a  book.    (Wash.) 

3.  Rule  a  cash  book  to  provide  for  controlling  ac- 
counts of  debtors  and  creditors,  also   for  discounts  in 
settlement    of    both    receivable    and    payable    accounts. 

(N.  Y.) 

4.  What  method  would  you  recommend  for  recording 
the  cash  receipts  on  the  general  cash  book  of  a  company 
operating   10   branch   houses,   each   depositing   its   daily 
receipts  in  a  separate  bank?    Describe  fully.     (N.  Y.) 

5.  Describe  the  system  of  running  a  discount  column 
in  the  cash  book  and  show  how  the  entries  are  made 
both  in  the  general  ledger  and  in  the  subsidiary  ledger. 
(B.  I.) 

6.  What  are  the  functions  of  the  cash  book?     De- 
scribe the  peculiarities  of  one  or  more  cash  books  with 
which  you  are  familiar.     (N.  Y.) 

7.  What  is  the  advantage  of  having  a  cash  account 
in  the  ledger?     (N.  Y.) 

8.  What  should  a  cash  account  in  the  ledger  show? 

(N.  Y.) 

9.  Draw  up  a  form  of  Cash  Book  for  a  corporation 
where  a  complete  Voucher  System  is  in  operation  and 
where  the  following  conditions  exist:     Two  Country  and 
Two  City  ledgers  are  kept,  also  an  operating  ledger  and  a 


CLASSIFIED  JOURNALS— Continued  271 

private  ledger.  It  is  a  practice  of  a  majority  of  the  cus- 
tomers to  take  advantage  of  the  discounts  given  for  cash 
in  thirty  days.  It  is  also  the  custom  of  the  corporation 
to  deduct  the  discount  they  intend  to  take  advantage  of 
on  goods  purchased  by  them,  by  means  of  a  column  in 
their  voucher  journal.  Their  business  is  such  that  20% 
of  their  sales  are  made  for  cash  and  10%  on  C.  O.  D's. 
The  chief  expenditures  of  the  corporation  are  for  woolen 
fabrics,  notions,  fuel,  light  and  labor.  (111.) 

10.  A  company,  engaged  in  the  manufacture  and  sale 
of  products,  desire  a  separation  of  their  expenses  under 
proper  divisional  or  department  heads.     Illustrate,  make 
your  own  selection  of  some  manufacturing  business,  and 
prepare  classification  of  accounts.    What  ledger  headings 
would  you  use?     (111.) 

11.  Submit  rulings  for  correlated  cash  book,  purchase 
book  and  sales  book,  to  classify  purchases  and  sales  in 
three   divisions  and   to  provide   for   miscellaneous   pur- 
chases.    Provision  must  be  made  to  record  cash  sales  in 
sales  book  and  in  cash  book  and  for  customers'  and  cred- 
itors' controlling  accounts.    Submit  "pro  forma"  monthly 
summary  entries  for  the  foregoing  books.     (N.  Y.) 

!_!.  A  retailer,  who  employs  four  salesmen  behind 
the  counter,  sells  for  cash  mostly,  but  a  limited  amount 
for  credit.  He  rents  the  store  room.  His  knowledge  of 
accounts  is  limited,  but  he  can  make  plain  debit  and  credit 
entry.  He  knows  which  side  of  the  cash  book  is  debit 
and  which  is  credit.  He  knows  how  to  post  to  the  ledger. 
Understands  nothing  about  opening  and  closing  the  books. 
Formulate  and  describe  the  simplest  method  on  which  to 
conduct  his  books,  he  to  keep  them  during  the  year,  you 
to  audit  and  balance  them  once  a  year,  and  take  off  a 
general  statement  and  trading  account.  (Penn.) 


272  ACCOUNTING  PRINCIPLES 

13.  Describe  the  various  uses  of  the  journal.     (N.  Y.) 

14.  Prepare  form  of  book  for  a  small  business  com- 
bining general  ledger,  general  journal  and  cash  book  in 
one  binding  to  show  transactions  involving  all  three  on 
each  double  page.     (111.) 

15.  Give  a  short  statement  covering  the  advantages 
or  disadvantages   of  a   voucher  system   and   of  tabular 
books.     (Penn.) 

16.  Prepare  a  ruling  for  an  invoice  book  to  provide 
for  total  monthly  charges  to  three  material  accounts  and 
two   expense   accounts,   and   also   to   detail    postings   to 
sundry  accounts  of  capital  and  revenue  outlay.     (N.  Y.) 

17.  Prepare  a  ruling  for  a  salesbook  to  provide  (1) 
total  monthly  postings  to  three  goods  accounts,   (2)   the 
separation  of  cash  sales  from  charge  sales,    (3)   supple- 
mentary   distribution    of    sales   among  four  salesmen's 
columns.     (N.  Y.) 

18.  Prepare   a    form   of   monthly    summary   journal 
entries  for  the  two  foregoing  books   of  original   entry. 

(N.  Y.) 

19.  Draw  up  a  form  of  "Check  Register"  to  be  used 
in  conjunction  with  a  complete  Voucher  System,  it  being 
intended  that  the  Check  Register  shall  take  the  place  of 
the  disbursement  side  of  the  Cash  Book  and  shall  also 
record  the  deposits  and  withdrawals  in  three  different 
bank   accounts.      Discounts    on    goods   purchased   to   be 
handled  through  the  Voucher  Journal.     (111.) 

20.  Give  headings  for  a  Voucher  Record  Book  suit- 
able  to   any   business   with   which   you   are   acquainted. 
State  briefly  some  advantages,  if  any,  and  disadvantages, 
if  any,  of  the  Voucher  System.     (Wash.) 

21.  A   wholesale   house  has   on   its  books   200   indi- 


CLASSIFIED  JOURNALS— Continued  273 

vidual  accounts  with  creditors,  500  with  city  customers, 
and  1, ri(K)  with  county  customers,  besides  about  75  im- 
personal, or  representative  accounts.  Owing  to  the 
method  of  bookkeeping  in  force,  it  is  necessary,  in  order 
to  ascertain  the  amount  of  Accounts  Receivable  or  Pay 
able,  to  take  off  a  complete  list  of  the  accounts  in  ques- 
tion. You  are  called  upon  to  advise  how  this  difficulty 
can  be  overcome,  and  also  as  to  whether  the  bookkeeping 
work  on  the  Accounts  Payable  cannot  be  reduced,  having 
regard  to  the  fact  that  the  firm  discounts  all  its  bills. 
Embody  your  suggestions  in  a  brief  report.  (Wash.) 

22.  Describe  what  is  known  as  the  Voucher  System. 
Can   a   Voucher  System  be  used  to  advantage  in  every 
business?     If  not,  state  certain  conditions  which  would 
militate  against  it.     (111.) 

23.  A  criticism  often  heard  in  respect  to  the  Voucher 
System  is  that  it  entails  too  much  red  tape.     Is  this  a 
just  criticism,  and  if  so,  under  what  circumstances?  (111.) 

24.  State   the   advantages   of   using   columns    in    an 
invoice  or  voucher  register  for  distributing  the  expendi- 
tures.    When  would  it  be  advisable  to  use  a  distribution 
ledger?     (N.  Y.) 

25.  Rule  in  proper  form,  a  double  page  of  a  voucher 
record  or  register  inserting  at  least  three  items  as  they 
should  appear  in  the  record,  showing  payment  of  those 
items.     Show  the  title  of  each  of  the  columns.     (N.  Y.) 

20.  What  is  meant  by  the  voucher  system  of  accounts? 
Why  is  it  particularly  adapted  to  large  corporations  or 
manufacturing  concerns? 

Illustrate  the  system  by  making  one  voucher,  that  of 
Peters  &  Boynton,  and  by  entering  in  the  necessary  books 
of  the  Anderson  Foundry  Co.,  the  following  items: 


274  ACCOUNTING  PRINCIPLES 

6/2  Received  from  Peters  &  Boynton,  Pittsburg,  Pa.,  12 
tons  pig  iron,  $15.00 ;  Term  2/5,  n/30. 

6/3  Bought  of  Holman  &  Co.,  500  tons  coal  @  $6.00,  for 
smelting  furnace. 

6/4  Paid  workmen,  as  per  pay  roll  $898.50. 

6/5  Rec'd  bill  from  United  Hdw.  Co.  for  putting  new  roof 
on  foundry,  $250.00. 

6/7  Paid  Peters  &  Boynton  for  invoice  of  6/2.     (N.  Y.) 

27.  Draw  up  a  form  for  the  record  of  household  ac- 
counts, or  of  a  small  trading  business,  that  may  be  used 
as  a  combined  cash  book,  journal  and  general  ledger. 
Give  the  headings  and  provide  five  distribution  columns 
for  expenditures  and  also  columns   for  controlling  ac- 
counts for  both  accounts  payable  and  accounts  receivable. 
(N.  Y.) 

28.  Compare  a  simple  arrangement  of  accounts,  as  for 
example,  capital,  cash,  merchandise,  personal,  expense, 
profit  and  loss,  with  some  other  scheme  of  accounts  ex- 
panded to  meet  the  demands  of  present  day  requirements. 
Describe  the  possibilities  and  advantages  of  the  more 
modern  scheme.      (N.  Y.) 

29.  Compare  the  advantages  and  disadvantages  of  a 
"Voucher  Record   System"  as   opposed   to   an   Accounts 
Payable    or    Creditors'    Ledger    System    with    Purchase 
Journal,  and  state  what  you  would  recommend.      (111.) 


INDEX 


Abandonment  of  Property 125 

Accidents,   Reserve  for 201 

Accommodation  Transactions  ...      96 

Account,   Defined    17 

Advertising    163 

Bank     207 

Bills  Receivable    216 

Bills  Receivable  Discounted  .5,  155 

Bond  Interest   167 

C'apital  Stock   221 

Cash   42,  80,  207 

Cash  Discount  on  Purchases.  .      59 

Cash  Discount  on  Sales 59 

Cash    Purchases    213 

Cash    Sales    213 

<  vrtificate  of  Deposit 81 

Construction    103 

D.-Hcit     198 

Depreciation    114 

Discount     44 

Dividends  Payable 21,  158,  222 

Donations     168 

Drawing     21 

Expense   r>6,  62,  222 

Equipment    .""•."..    r>0,   100 

Express  on  Purchases 59 

Express  on  Sales 59 

Freight  and  Express 55,     59 

Freight  on  Purchases 59 

Freight  on  Sales 59 

Goodwill 56,  61,  101,   140 

Gross   Profit    68 

Heat   62 

Income   238 

In  Freight 59 

Insurance   56,     62 

Interest  and  Bank  Discount..      58 
Interest  and  Discount....   55,     58 
Interest   on    Bonds   and    Mort- 
gages           58 

Interest  on  Investments 59 

Interest  on  Loans 58 

Inventory 57,   69  180 

Investment    225 

Land  and  Buildings 55,     61 

Loss  and  Gain 238 

Machinery .">.  r,<).   106 

Manufacturing    238 

Material 223 

Merchandise "»,   56.     60 

NIM    Profit 91,   96.   100 

Out  Freight 59 

Plant 55.  »;o.  100.  1015.  225 

Premium  on  Capital  Stock.  ...   167 

Prepaid   Expense    163 

Profit  and  Loss 238 

Profit  and  Loss  Adjustment..    159 

Purchases   67.     69 

Raw  Material   73 

Real   Estate  Investments 90 

Rent 56.     62 

Reserved  Bonds    157 

Reserved  Stock  .  62 


Account      Continued 

Reserve'  for  Damages  to  Leased 

Property     180 

Reserve    for    Deterioration    of 

Stock    179 

Reserve    Fund    for    Contingen- 
cies     182 

Reserve   Fund   to  Provide   Ex- 
tensions      182 

Revenue 10,  22,  238 

Salary    223 

Sales 67,  68,  180,  212 

Special  Advertising 163 

Subscription    221 

Sundry   Debtors    217 

Surplus 158,   173,  175 

Suspense    226 

Trading 57,  69,  238 

Treasury  Stock 56,  62 

Undivided  Profits 158,  167, 

175.  176,  179,  197,  243 

Unexpired  Insurance   162 

Unissued  Bonds    157 

Unissued  Stock 62 

Unsubscribed  Stock 62 

Vouchers  Payable 265 

Accountant,  Certified  Public.  ...  18 

Defined 17 

Public 18 

Accounting,  Defined 17 

Estate    29 

Municipal     5 

Accounting  Terminology 58 

To  Prevent  Fraud 47 

Accounts,  Adjustment.  .220,  224, 

227,  255 

Branch    77/9,  212 

Character  of   19 

Collective 52,  54,  216 

Combined    28,  226 

Contents  of 52,  54 

Controlling 20,  220,  224, 

227,  233,  255 

Corporation   21 

Current    53 

Deposit     53 

Divisions  of 19 

Form  of 24 

Headings  of 56,  66 

Impersonal     22 

Individual 55.  66 

Major 52.  54,  173 

Mixed 54.  55,  66 

Payable 225.  LM;.- 

Personal    20,  44 

Proprietorship     20 

Real    22 

Receivable    224 

Reserve   172.  248 

Rest    52 

Revenue 10.  22.  238 

Specific   55,  66 

Stockholders    21 


276 


INDEX 


Accounts — Continued 

Subsidiary 52,  162,  207 

Summary 52,  54 

Suspense    165 

Accrued  Expenses 165 

Accumulation    of    Sinking    Fund 

Investments 194 

Adjuncts    53,  248 

Adjustment  Accounts ..  220,   224, 

227,  2r,5 
Adjustments   of   Profit   and   Loss 

Account    159 

Administration  Section 241 

Advertising  Account    163 

Advertising   Appropriations    ....  163 

Affairs,   Statement  of 9 

Alameda    Supply    Co 13/9 

Allowances  for  Damaged  Goods.  .  68 

Altering  and  Moving 106 

American  Manufacturing  Co.. -04/1 4 

Amortization,  Bond   94 

Annuity  Plan  of  Depreciation.  .  .  120 

Appreciation 109,  117 

Approval,  Sales  on 68 

Articles  Prepared  for  use  of  Firm  105 
Assets  and  Liabilities,  Statement 

of    9 

Assets,  Capital 84,  99,  165 

Circulating    86 

Current    84,  248 

Fixed   84,  249 

Floating 84 

Non-Ledger 4,  5 

Wasting   126 

Auditing 17 

Audit  of  Single  Entry 8 

Bad  Debts  and  Goodwill 143 

Bad  Debts,  Reserve  for.  171,  174,  241 

Badwill     149 

Balance  Book    46 

Ledger    27 

Balances.   Proof  by 234 

Balance  Sheet ' 9.  173.  247 

Sheet  Consolidation 92 

Bank  Account 207 

Columns  in  Cash  Book 45 

Ledger    31 

Barchester   Brewery   Co 152 

Betterments     106 

Bills  Receivable  Account.  .  .   175,  216 
Receivable  Discounted  Ac- 
count          5,  155 

Receivable  Ledger    216 

Book,  Daily  Balance 46 

Petty   Cash    211 

Sales     255 

Sales,    and    Gross    Profit    Col- 
umn       68 

Bookkeepers  as  Accountants ....  17 

Bookkeeping    1 

Books.  Tabular 255 

Bond   Amortization       . .  .  . 

Interest  Account    1 07 

Issue,    Interest   on 103 

Register    157 

Bonds.    Discount    and    Premium 

on      103 

Discount    on    164 

Expense   of   Issue  of 164 


Bonds — Con  tinned 

Interest  on    166 

Investments  in 93 

Issued  for  Construction 103 

Payable 156 

Premium   on    166 

Boston  Bank  Ledger 31 

Branch   Accounts    77/9 

Inventories     214 

Branches    212 

Bristol   Mfg.   Co 160/6 

Buildings,  Depreciation  on..  115,  128 

Capital     11 

Account,    Sole   Trader 20 

and  Revenue..  84,  91,  105,  117,  145 
and    Revenue    Method    applied 

to   Municipal   Bookkeeping.  .        5 
and  Revenue  Method  of  Double 

Entry   Bookkeeping    3 

Assets 84,    99,   165 

Expenditures    84,   101 

Income    84.     99 

Capitalized    Royalties 79/14 

Capital    Liabilities 156,250 

Receipts     84 

Stock    99 

Stock   Account    221 

Stock  and  Subscription  Ledger 

29,   221 

Cash  Account 42,  80,  207 

and   Bank,   Separate   Books.  . .      48 

Book      42 

Book,    Bank    Column 45 

Book,    Discounts   in 43 

Book.    Tabular    43 

Bock,   Two   Column 42 

Discount 58,    59,   241 

Discount     on     Purchases     and 

Goodwill     142 

Discount,    Reserve    for 175 

Imprest     .*  .  .  .    210 

Journal.    Private    227 

Journals     255 

Petty    210 

Purchases    213 

Records     42 

Sales     213 

Certificate.    Desirability    of    pos- 
sessing           18 

Certificates  of  Deposit 81 

Certified    Public    Accountant....      18 
Public    Accountants'    Examina- 
tion Questions.  .  .    7.   12,  23, 
63.  76.  83.  89,  97.   110.  133. 
150.  160.  185.  201,  215.  228. 

237,    244,    251,   270 

Character  of  Accounts    19 

Charges  and  Credits.  Proof  by..    235 

Check  Register    48 

Voucher    2.59 

Chronological    Record....    24.   40.  47 

Circulating  Assets    86 

Classified  Journals 38.   255 

Chili   Ledger    32 

Collective  Accounts.  .52.  54.  216.   233 
Columnar  Books.  .Advantage  of .  .      39 

Combined    Acc-unts 28.   226 

Common    Stock 148.   158 

Stock  and  Goodwill 148 


INDEX 


277 


Consignment  Sales 68 

Consolidating  Balance  Sheets...  92 

Consolidations  and  Goodwill....  146 

Construction   Account    103 

Contents  of  Account* 52,  54 

Contingencies,    Reserve   for 158 

Contingent   Fund    193 

Liabilities 4,    1.">,  250 

Contracts.        t'ncompleted,       and 

Profits     44 

Controlling  Accounts.  .  .  .  20,  220, 

224,  227.  L'.-.r, 

Conversions      108 

Copyrights,  Depreciation  of 132 

Corporation  Accounts   21 

Corpus    and    Income 2!> 

Cumulative  Preferred  Dividends.  156 

Preferred    Stock 147,158 

( 'nrrent    Account    53 

Assets 84,    86,  248 

Liabilities    85,  248 

Customers'  Ledger   255 

<'ut    I 'ages    33 

I  )a  ily    Balance   Book 46 

Damaged  Goods,  Allowances  for.  68 

Day   Book    8 

Debtors.   Sundry 217 

I  •••ferred  Charges    LT.U 

Deficit   Account    198 

Detail    Columns    Ledger 28 

Deteriorated     Goods     in     Inven- 
tory       75 

Deposit    Account    

Deposits.  Certificates  of 81 

Deposit    Register    48 

I  Depredation    114 

and   Goodwill    142 

Methods    of    Computing 119 

on  Different  Objects 128 

K. -serve   for 176,  225 

Discount   Account    44 

ami   Interest,   Divisions  of 58 

Cash    58,  241 

Discounted   Bills  Receivable.  ..5.  155 

Discount    on    Bonds 103,  H>4 

on   Purchases    44 

on  Sales 44 

on    Stock 01.    102,  146 

•  11    Treasury    Stock 108 

Discounts    in    Cash    P.ook 43 

Trade    58.  .">!> 

Dissolution    of    Partnership.     In- 
ventory      71 

Distribution   Ledger    208 

Dividends.    Cumulative    Preferred  1."><; 

on  T'ncompleted  Contracts.  ...  74 

Payable  Account 158.  222 

Slock     200 

Donations    Account    168 

Double    Account    System 104 

Entry    ' 1 

Drawing  Account    21 

Duty    7.*',.  240 

East   and   West   Railroad   Co...  77/10 

Entries  for    Sinking   Fund 194 

Equipment  Account ."."».  ."9.  100 

Depreciation    of    130 

Ledger   T>0.  1 00 


Errors   Localized    30 

Expense  56 

Account  62,  222 

Ledger  222 

of  Bond  Issue 164 

Overhead  105 

Expenses  Accrued  165 

Incurred  in  Advance  of  Sales..  163 

Organization  87,  102 

I 'repaid  249 

Extensions,   Reserve  for 15S 

Fences  and  Sidewalks,  Deprecia- 
tion   on    128 

Finished  Gocds 74 

Fire  Losses 72,  79/16 

Losses,  Reserve  for 178 

Fixed   Assets    84.  l'4!» 

Fluctuation   of    86 

Sale    of    10 

Fixed  Liabilities   85,  249 

Fixtures.    Depreciation    of 129 

Sale  of 67 

Floating  Assets    84 

Liabilities    85 

Fluctuation  of  Current  Assets.  .  86 

of  Fixed  Assets 86 

of  Reserve  Fund  Investments.  198 

Foot  ings.    Proof  by 234 

Form  of  Accounts 24 

Questions  on .",r>,  41,  50 

Voucher    201 

Freight  and  Express 55.  59 

Charges    70 

Fund,  Contingent 193 

Insurance    192 

Investment    193 

Redemption     193 

Replacement    120 

Reserve 172,  181.  195,  248 

Revolving    210 

Trust    81 


General    Ledger    ..............  227 

Goods  in  Process,  Sale  of  ......  68 

Goodwill    ................    140.  242 

Account    ............    56,  61.  101 

and  Common  Stock  ..........  148 

Depreciation   of    ............  132 

in  Consolidations   ...........  146 

Increased  .............  146.  64/6 

Writing  off    ................  149 

Gross  Profit   ..............    57.  71 

Profit  Account    .............  08 

Guaranteed    Goods,    Liability    on 


Headings  of  Accounts  ......    56,  00 

Heat  Account   ................  02 

Hidden   Reserves    .............  183 

Holding  Company.  Inventory  of.  73 

Company  Investments   ...'....  92 

Horses.   Depreciation   of  ........  130 

Impersonal    Accounts     .........  22 

Imprest  Cash    ................  210 

Income  Account   ..............  238 

and  Corpus    ................  29 


278 


INDEX 


Income — Continued 

and    Expenditures,    Statement 

of    80 

from  Sinking  Fund 195 

on    Reserve    Investments    and 

Reserve  for  Depreciation .  . .  196 
Individual  or   Specific  Accounts. 

55,  66 

In  Freight 67,  73,  240 

Interest    119,  242 

and  Discount  Account....   55,  58 

on   Bonds    103,  166 

on   Installment   Purchases....  101 

Installment   Purchases    101 

Insurance    Account    56 

Account,  Divisions  of 62 

Fund    192 

Paid  in  Advance 162 

Integral   Units  of  Business 22 

Internal  Check    209 

Inventories    214 

and   Goodwill    144 

Inventory     240 

Account 57,  69,  180 

Account,  Divisions  of 72 

Account,   Operation   of 70 

and    Post    Dated    Invoices.  ...  67 

Deteriorated  Goods    75 

Finished  Goods 74 

Holding  Company    73 

Obsolete  Gcods 75 

Partly  Finished  Goods 74 

Value  without   Count 76/6 

Investment  Account    90,  225 

Fund     193 

in  Mining  Companies 92 

Ledger    225 

of  Partners   21 

Investments     90 

and    Treasury    Stock 64/5 

Fluctuation  of  Reserve  Fund.  .  198 

in  Bonds    93 

in  Real  Estate 90 

in  Securities   95 

in  Stocks 91 

Outside     10 

Reserve    190 

Invoice  Book 39 

Invoices.    Post   Dated 67 

I.  O.  U.'s  Treatment  of 82 

Journal,   Chronological    40 

Debits  and  Credits  widely  Sep- 
arated       25 

Standard    24 

Vouchers    267 

Journals.  Cash   255 

Classified    38,   255 

Land  and  Appurtenances.  Depre- 
ciation  of    128 

and  Buildings    55,  61 

Lapping  System   209 

Leaders    30 

Leaseholds 87,  119.  129 

Ledger,  Analysis  of 10 

Balance    27 

Bills  Receivable    216 

Boston  Bank 

Club 32 


Ledger — Continued 

Customers' 20,  224,   255 

Detail   Column    28 

Equipment 60,   106,   126,  225 

Estate    29 

Expense    222 

General    227 

Investment     225 

Journal     257 

Lock   223 

Membership   32 

Plant 60,  106,  126,  225 

Principal  and  Income 29 

Private     226 

Proof    30 

Purchase    225 

Salaries    223 

Sales 20,  224,  255 

Special  for  Monthly  Totals...      27 

Standard    26 

Stock 29,  221 

Stores     223 

Sundry  Debtors'    218 

Suspense    226 

Tabular    30 

Tabulating     10 

Telephone     32 

to  Facilitate  Reference 26 

Wide  Explanation  Columns...      29 

Liabilities    154 

Capital    250 

Contingent    4,  250 

Current    85,   248 

Fixed 85,   249 

Floating 85 

on  Contracts  and  Goodwill...    143 

on   Guaranteed  Goods 5 

Localizing  Errors 30 

Lock   Ledgers    223 

Long  and  Short  Pages 269 

Loss  and  Gain  Account 238 

and  Gain  Method 10 

Losses,   Fire    72 

on  Bills  Receivable 175 

on  Partly  Manufactured  Goods     74 

Machinery  Account 55,  59,   106 

Depreciation   of    130 

Major  Accounts 52,   54,   173 

Manufacturing  Account    238 

Section   239 

Mapes  &  Manning 152 

Material  Account   223 

Membership  Ledger    32 

Merchandise  Account...    55.   56,     69 
Methods  of  Computing  Deprecia- 
tion         119 

Mixed  Accounts 54,  55,     66 

Mines,   Quarries,   etc 88 

Mining  Company  Investments.  .  .      92 

Moving  and  Altering 106 

Municipal  Accounting   5 

Narrow  or  Short  Pages 33 

Necessity    of    Providing   for    De- 
preciation       115 

Net  Profit 57.   103.  164 

Profit  Account 91,   96.  101 

Profit  Section    241 

Worth 3,  11 


INDEX 


279 


Nominal   Accounts    22 

Non-Ledger  Assets 4,        5 

Non  Producing  Assets    01 

Nnrt  h  &   South   K.   R 111/11 

Nntes.    Overdue     226 

<  H>solescence 107.  1  L':: 

obsolete  Goods  in  Inventory ....  75 

offset    ;  .   53.  248 

On  Cost 73,  105 

orchards.  Depreciation  on 128 

Ordinary  Business  Profit 4,  241 

Organization    Expense 87,  102 

outside    Investments 10,  142 

overdue   Notes    226 

Overhead   Expense    105 

Pages.   Narrow  or  Short 33 

Partners   and  Goodwill 146 

Partner's  Investment 21 

Investment,   Interest  on 58 

Partnership    21 

Dissolution  of  and  Inventories     71 

Patents.    Depreciation   of 131 

Royalties  on    74 

Pa  it  ems.    Depreciation    of 131 

Personal    Accounts 20.     44 

Petty   Cash    210 

Cash  Book 211 

Plant  Account.  .55.  60.  100.  106,   225 
and     Equipment.     Depreciation 

on    118 

and  Equipment  Ledger.  60. 126.   225 

Post  Dated  Invoices 67 

Preferred    Stock 158.    100 

Premium    on    Bonds 103.   166 

on   Capital    Stock   Account....    167 

on    Stock    1 67 

on    Treasury    Stock 168 

Prepaid    Expense        240 

Expense   Account    163 

Present  Worth  in  Single  Entry.  .        0 
Principal  and  Income  Ledger.  ...      20 

Private  Cash  Journal 227 

Ledger    226 

Profit    57 

and   Loss    10 

and   Loss   Account 238 

and  Loss  Account  Preparation     10 

and   Loss   Adjustments 150 

and  Loss  Adiustment  Account.    150 
and    Loss    Appropriation    Sec- 
tion         243 

Ascertaining    0 

Gross     68 

Net    ._ 1 03 

on  Contracts 74 

on  Trading   240 

on   Turnover    68 

Ordinary  Business    241 

or  Loss.  Method  of  Ascertain- 
ing            3 

or  Loss  on  Ordinary  Business.      10 

Trading    240 

Profits  and  the  Inventory 60 

Extraordinary 10 

Proof  hv  Balances 234 

by  Charges  and  Credits 235 

by  Footings 234 

Tabular    39 


Proof — Cnn  tin  u<  <l 

Ledger    30 

Sheets     255 

Property,    Abandonment   of 125 

Sale  of 115 

Proprietorship    3,  158 

Accounts     20 

Purchase  Account 67,  60 

Account,  Divisions  of 67 

Book   39 

Journal     40 

Ledger    225 

Purchases   57,  213 

Discount  on 44 

Installment    101 

Quarries     88 

Questions  for  Written  Work .... 
35.  41,     50 


Raw    Material    Account 

Real    Accounts    

Estate  Investments    

Receipts  and  Disbursements 
Method  of  Double  Entry 
Bookkeeping  

and  Disbursements.   Statement 

of    

Reconciliation  of  Bank  and  Cash 

Redemption    Fund    

Register.  Check  or  Deposit 

Renewals.  Reserve  for 178. 

Rent  Account 56, 

Repairs     

and  Renewals 116.  122, 

Replacement  Fund   

Replacements   106. 

Reserve  Account 172. 

Accounts  and  Investments.  .  .  . 

Account,  Stock  in  Trade  Fluc- 
tuation    

for  Accidents    

for  Bad  Debts 171.  174. 

for  Cash  Discount 

for  Damages   to   Leased   Prop- 
erty      

for  Depreciation 1 76. 

for    Depreciation    and    Income 
on  Reserve  Investments.  .  .  . 

for  Depreciation  of  Machinery 

for  Deterioration  of  Stock .... 

for  Fire  Losses 

for  Renewals    178. 

Fund 172.  181.  105. 

Fund   for  Contingencies 

00.   158. 

Fund   for  Extensions ....    1 58. 

Fund   Investment 00. 

Fund  Investments,  Fluctuation 
of    

Secret  

Reserved   Bonds   Account 

Stock    

Stock  Account 

Reserve  Investments   

Reserves     

Secret  or  Hidden 

Residual  Values.  Table  of 

Rest   Account    

Resource  and  Liability  Method.  9. 


73 
22 
00 


3 

80 
207 
103 

48 
225 

62 
176 
126 
120 
176 
248 
191 

71 
201 
241 
175 

180 

9  or. 


106 
60 
170 
178 
005 

248 

182 
182 
100 

198 

149 

157 

158 

62 

100 

171 

183 

132 

52 

10 


280 


INDEX 


Revenue  Accounts 6,  10,  22,  238 

Revenue  and  Capital 84,  91, 

105,   117,  145 

and  Expenses,  Statement  of.  .  .  80 

Expenditures 85 

Income   85 

Receipts   85 

Reversions   87 

Revolving  Fund   210 

"Rights,"  Stockholders' 168 

Robinson   &  Co 13/6 

Royalties,  Capitalized   79/14 

Royalties  on  Patents 74 

Salaries  Ledger    223 

Salary  Account 223 

Sale  of  Capital  Assets 86 

of  Fixtures    67 

of  Goods  in  Process 68 

of  Property 125 

of  Undertaking,  Inventory ....      71 

Sales    57,   212 

Account 67,   180,   212 

Book 39,  68,   255 

Cash   213 

Consignment    68 

Discount  on 44 

Ledgers   20,  224 

on  Approval    68 

on  Approval  and  Goodwill ....    143 

Secret  Reserves 149,  183 

Securities,  Investment  in 95 

Selling  Price  Apportioned 68 

Short  or  Narrow  Pages 33 

Simple   Entry    1 

Single  Account  System 104 

Entry    1 

Sinking  Fund  Entries 194 

Fund  Income 195 

Fund   Investment 90,  190 

Fund  Investment  Accumulation  194 

Fund  Reserve    193 

Smith,    John    15/13 

Smith  &  Co.,  James 13/2 

Sole   Trader,    Proprietorship   Ac- 
counts           20 

Special  Advertising  Account.  .  . .    163 

Specific   Accounts 55,     66 

Statement  of  Affairs 9 

of  Assets  and  Liabilities.  .  .  9,  11 
of  Income  and  Expenditures.  .  80 
of  Receipts  and  Disbursements  80 

of  Revenue  and  Expenses 80 

Stock  and  Goodwill 148 

Capital   99 

Common   148 

Cumulative  Preferred    147 

Discount  on 61,  102,   146 

Dividend    . 200 

in  Trade,  Fluctuation  in  Value     70 

Investment  in 91 

Ledger 29,  221 

Preferred   190 

Premium   on 167 

Reserved  or  Unissued 62,  158 

Treasury    62 

Unissued . 62 

Unsubscribed 62 

Valuing 70 

Watered    ...... .  . .......    60,     61 


Stockholders'  Accounts    21 

"Rights"  168 

Stores  Ledger  223 

Subscription  Account  221 

Subsidiary  Accounts.  ...  52,  160,  207 

Suburban  Traction  Co 113/17 

Summary  Accounts 52,  54 

Sheet  269 

Sundry  Debtors  217 

Debtors'  Ledger  218 

Surplus  Account 158,  173,  175 

Suspense  Accounts  165,  226 

Ledger    226 


Table  of  Residual  Values 132 

Tabular   Books    255 

Cash  Book 4i\ 

Ledger    30 

Proof 39,  43 

Tabulating  a  Ledger 10,  12/1 

Taxes    91 

Accrued  and  Unpaid 166 

Telephone  Ledger 32 

Terminology   5"8,  238 

Tools,  Depreciation  of 131,  178 

Trade  Discounts    58,  59 

Trader,    Proprietorship   Accounts 

of  Sole 20 

Trading  Account 57.  69,  238 

Profit 57,  240 

Section 240 

Treasury  Stock   56 

Stock  Account 62 

Stock,   Discount  on 168 

Stock,   Premium  on 168 

Stock,  Purchased    65/8 

Trial    Balance 233,  247 

Trust  Funds    81 

Turnover 68,   69,  240 


Undertaking,   Sale  of  and  Inven- 
tory           71 

Undivided  Profits  Account.  .  158, 

167,  175,  176,  179.  197,   243 
Unexpired  Insurance  Account.  .  .    162 

Unissued    Bonds'    Account 157 

Stock  Account 62,   158 

Unsubscribed  Stock  Account ....      62 
Utility  Mills   186 


Valuing  Stock 70 

Ventures     68 

Voucher  Check    259 

Distribution  Ledger  or  Journal  267 

Form     261 

Record 265 

Register    258 

System  259 

Vouchers,  Journal  267 

Payable  .         265 


Watered  Stock .  60,  61 

Wasting  Assets 126 

Assets,  Patents  as 132 

Writing  up  Goodwill 145 

off  Goodwill  149 

Working  Capital.  .  .  84.  104,  165,  167 


14  DAY  USE 

RETURN  TO  DESK  FROM  WHICH  BORROWED 

LOAN  DEPT. 

This  book  is  due  on  the  last  date  stamped  below,  or 

on  the  date  to  which  renewed. 
Renewed  books  are  subject  to  immediate  recall. 


flfct'63S8 

C'PUD 

mu      7'63-9M* 

N0\l     '  D0 

T  r»  01  A    /<r>«,  /i  '«Q                                      General  Library 
^G^rsfoHT'eB3                             UnivershyrOfeCalifornia 

